Financial Statements
The financial statement is one of the key components of an annual report that provides a comprehensive overview of a company’s financial performance and position.
As a result, stakeholders, including investors, creditors, and regulatory bodies, need to assess the company’s health and viability based on these reports, prepared by the company’s management.
An annual report includes three financial statements: the balance sheet, the income statement, and the cash flow statement.
i. Balance Sheet:
An organization’s balance sheet, also referred to as a statement of financial position, describes its assets, liabilities, and shareholders’ equity as of the end of the fiscal year.
The balance sheet provides a snapshot of the organization’s financial condition and helps determine its solvency and liquidity. Assets = Liabilities + Shareholders’ Equity is the fundamental accounting equation.
a. Assets:
An asset is a resource that the company owns, such as cash, receivables, inventory, property, equipment, and investments. A current asset is one that will be converted into cash within one year or a noncurrent asset is one that will be converted into cash within a year.
Among the current assets of a company are cash and cash equivalents, short-term investments, receivables, inventory, and prepaid expenses. A non-current asset is a long-term investment, property, plant, and equipment, or an intangible asset.
b. Liabilities:
An organization’s liabilities include accounts payable, loans, and accrued expenses. As with assets, liabilities are classified either as current or non-current.
Current liabilities are those that are due within a year and those that are due after a year. Long-term debt, deferred tax liabilities, and other long-term liabilities are non-current liabilities.
Current liabilities include accounts payable, short-term debt, accrued expenses, and taxes payable.
c. Shareholders Equity:
An entity’s shareholders’ equity is the residual interest after deducting its liabilities from its assets. Among the components are common stock, retained earnings, and additional paid-in capital.
Common stock represents the par value of the shares issued to shareholders. The retained earnings represent the accumulated profits or losses that the company has retained, rather than distributed as dividends.
As a result of the balance sheet, stakeholders can gain insight into the company’s financial health and value.
It can be determined whether the company has a positive net worth or if it is overburdened with debt by comparing the total assets and liabilities.
Also, the composition of assets and liabilities can provide valuable information about a company’s long-term financial obligations and liquidity.
ii. Income Statement:
In the income statement, which is also known as the statement of profit and loss or statement of operations, a company’s revenues, expenses, gains, and losses are presented in detail for a specific period.
This helps determine if a company is profitable and efficient at generating profits.
a. Revenues:
A company’s revenues are determined by its primary operations, which include selling goods or services to the public, as well as interest or dividend income. They are usually classified according to the type of business.
As an example, a manufacturing company may generate revenues through the sale of products, while a service-based company might generate revenues through the provision of services.
b. Expenses:
Companies incur expenses as a result of generating revenue, including costs of goods sold, operating expenses (such as salaries, rent, utilities), interest expenses, and taxes.
In order to give a detailed breakdown of the company’s cost structure, expenses are typically categorized into different groups.
c. Gains and Loses:
A company’s gains and losses are the net results of transactions and events not directly related to the company’s primary operations.
It is important to report these items separately from revenues and expenses to get a clearer picture of the company’s core operations. For example, gains or losses from asset sales and investments.
An income statement shows a company’s net income or loss, which is determined by subtracting total expenses from total revenues.
Using the income statement, stakeholders can determine if the company is profitable and able to generate a positive bottom line.
It helps stakeholders determine if the company is growing revenue, managing costs, and improving profitability. The system also allows for benchmarking against industry peers and comparing performance over time.
iii. Cash Flow Statement:
In a cash flow statement, a company tracks the amount of cash it receives and spends during a specific period, typically a fiscal year.
In addition to assessing the company’s cash generation, liquidity, and ability to meet its financial obligations, it provides information about the company’s operations, investments, and financing.
a. Operating Activities:
An operating activity is a cash flow generated by a company’s primary operations, including payments to customers, suppliers, and employees, and cash received from customers.
An operating-related cash flow section typically contains net income, adjustments for non-cash expenses, changes in working capital, and other operating-related cash flows.
b. Investing Activities:
A business invests in long-term assets, such as property, equipment, and investments, in order to generate cash flows.
In addition to the purchases or sales of equipment and property, investments, and loans made to or gathered from third parties, investing activities produce cash flows.
c. Financing Activities:
A financing activity is one that involves raising or repaying capital, such as issuing or repurchasing stocks, paying dividends, or obtaining loans.
In addition to proceeds from the issuance of stocks and bonds, financing activities also result in dividends and other cash flows that are related to financing activities.
Cash flow statements reconcile the starting and ending cash balances by indicating the net decrease or increase in cash and cash equivalents. They help determine the company’s cash management ability.
In contrast, negative cash flow raises concerns about liquidity and the need for external financing, while positive cash flow indicates the company can generate cash from its core operations.
A company’s financial statements offer a comprehensive view of its performance, position, and cash flows in an annual report. In addition to assessing the solvency and liquidity of the company, the balance sheet provides insight into revenues, expenses, gains, and losses.
An analysis of the cash flow statement allows stakeholders to assess the company’s cash generation and liquidity.
They can then invest, lend, or engage in business with the company based on this information.
MCQs related to Financial Statements
Some of the MCQs related to Financial Statements are as follows:
i. Which financial statement provides a snapshot of a company’s financial position at a specific point in time?
- a) Income Statement
- b) Cash Flow Statement
- c) Balance Sheet
- d) Statement of Changes in Equity
Answer: c) Balance Sheet
ii. Which financial statement shows a company’s revenues, expenses, gains, and losses over a specific period?
- a) Cash Flow Statement
- b) Statement of Changes in Equity
- c) Income Statement
- d) Balance Sheet
Answer: c) Income Statement
iii. Which financial statement tracks the flow of cash in and out of a company during a specific period?
- a) Balance Sheet
- b) Income Statement
- c) Cash Flow Statement
- d) Statement of Changes in Equity
Answer: c) Cash Flow Statement
iv. The fundamental accounting equation, Assets = Liabilities + Shareholders’ Equity, is associated with which financial statement?
- a) Cash Flow Statement
- b) Balance Sheet
- c) Income Statement
- d) Statement of Changes in Equity
Answer: b) Balance Sheet
v. The statement of changes in equity shows:
- a) Cash inflows and outflows of a company
- b) Changes in a company’s financial position over time
- c) Changes in shareholders’ equity during a specific period
- d) Revenue and expenses of a company during a specific period
Answer: c) Changes in shareholders’ equity during a specific period
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I am Bijisha, an enthusiast with a profound eagerness for learning. I hold a Bachelor’s degree in Business Administration(BBA) from Apex College. I am constantly driven by a relentless curiosity and a genuine desire to expand my knowledge horizons.
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