BASIC FINANCIAL STATEMENTS: WHAT THEY ARE FOR, CALCULATION, EXAMPLES - DUDAS - 2025

The basic financial statements are formal records that transmit the business and financial performance of a company. They are often audited by accountants or government agencies to ensure their accuracy and for tax, financial, or investment purposes.

The set of financial statements generally contains an income statement, a balance sheet, and a cash flow statement. They are also known as financial reports. The information and financial position of the company are presented with a structure, so that it is easy to understand.

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For large corporations, these statements can be complex. Therefore, they may include a management discussion and analysis, as well as a comprehensive set of footnotes.

These notes describe in more detail each item in the income statement, balance sheet, and cash flow statement. The notes to the financial statements are considered an integral part thereof.

Financial information

These statements are prepared to provide more information to users outside the organization, such as creditors and investors, about the financial health of the company.

Listed companies are also required to file these statements along with others in a timely manner to regulatory agencies.

For many managers, directors and investors, financial statements are the main tool to obtain information about the finances of a company. For this reason, financial accounting gives great importance to the significance, veracity and precision of the information contained therein.

What are they for?

They are used by investors and creditors to assess the earning potential and financial condition of an organization. They are useful for the following reasons:

- Determine the ability of a company to generate cash.

- Determine if a company has the ability to pay its debts.

- Track financial results to detect any impending profitability problems.

- Generate financial indicators that can show the condition of the business.

- Investigate the details of certain commercial transactions, described in the notes attached to the statements.

The three main financial statements are the income statement, the balance sheet, and the cash flow statement.

Balance sheet

Helps evaluate the financial health of a business. When you analyze over multiple accounting periods, you can identify the underlying trends in the company's financial position.

It is useful for determining the status of liquidity risk, financial risk, credit risk and commercial risk of an entity.

When used in conjunction with competitors' financial statements, the balance sheet helps identify relationships and trends that are indicative of potential problems or areas for improvement.

Therefore, balance sheet analysis could help predict the amount, timing and volatility of the entity's future earnings.

Statement of income

It provides the basis for measuring a company's performance during an accounting cycle. It can be evaluated in terms of the following:

- Changes in sales revenue during the period and compared to industry growth.

- Changes in gross profit margin, operating profit and net profit during the period.

- Increase or decrease in net profit, operating profit and gross profit during the period.

- Comparison of the profitability of the company with other organizations that operate in similar industries or sectors.

Cash flow statement

Provides important information on the solvency and liquidity of an organization, which are essential for the growth and survival of any business.

By compiling the major changes in financial position over a period, it helps to distinguish managerial priorities.

The cash flow data is more objective than the financial benefit shown in the income statement, which is susceptible to eloquent changes caused by the use of different accounting policies.

Basic financial statements

- Balance sheet

Provides an overview of a company's assets, liabilities, and equity, like a snapshot over time. The date at the top of the balance sheet indicates when that photo was taken.

It records how assets are funded, either with liabilities, through bank loans, or with equity, through retained earnings.

Assets are listed on the balance sheet in order of liquidity. On the other hand, liabilities are listed in the order they will be paid.

Assets

- Cash and its equivalents are liquid assets.

- Accounts receivable are the amount of money that customers owe the company for the sale of a product or service.

- Inventories.

Passives

- Debts, including long-term debt.

- Income, taxes and profits.

- Salaries to pay.

- Dividends payable.

Heritage

It is the total assets of an organization minus its total liabilities. It corresponds to the amount of money that the shareholders would receive if all the assets were liquidated and all the debt of the organization were paid.

- Statement of income

Provides an overview of a company's expenses, income, and profits over a specific period of time.

The main objective is to convey details about the profitability of business activities. It can also show if sales or revenue are increasing compared to other periods.

Types of income

Operating income is income received basically from the sale of products or services. They are generated from the essential business activities of an organization.

Non-operating income is that which is received through tasks that do not belong to the main function of the company. Some examples are:

- Income from the rental of a property.

- Interest earned on money deposited in the bank.

- Income from strategic associations, such as royalty payments.

Expense types

Primary expenses are those committed during the process of obtaining income from the main activity of the business.

They contain the cost of merchandise sold, general and administrative expenses. For example, sales commissions, employee salaries, and utilities like transportation and electricity.

Secondary expenses include losses from machinery liquidation, or interest disbursed on loans.

- Cash flow statement

It assesses the extent to which an organization generates money to finance its operating expenses, pay its debt obligations and finance investments.

It enables investors to understand how a business operates, where their money comes from, and how money is spent. It also provides information on whether a company has a solid financial base.

Operational activities

It contains all the sources and uses of cash to run the business and sell the products or services.

The cash from operations comes from the different transactions carried out in the inventory, collections from clients and cash sales.

They also include wages, tax and interest payments, rents, and receipts for payments to suppliers.

Investment activities

They are all the sources and uses of money corresponding to the investments of a company in the long-term future.

For example, loans received from banks or granted to suppliers, sale or purchase of an asset, or any payment related to an acquisition or merger.

Financial activities

They are the sources of cash for banks or investors, as well as the use of money paid to shareholders.

For example, debt and equity issuance, bank loans, share buybacks, dividend payments, and debt repayments.

How are financial statements calculated?

Balance sheet

The balance sheet is structured in such a way that the total assets of a company are equal to the sum of the liabilities plus the equity.

Assets can be financed from internal sources (share capital and profits) or external credit (bank loans, commercial creditors, etc.).

Since the total assets of a company must equal the amount of capital invested by the owners and any loans, the total assets must equal the sum of the capital and liabilities. Balance sheet totals are identified as follows:

- Total assets are placed on the balance sheet for the period.

- All liabilities are totaled, which should be a separate list on the balance sheet.

- The total equity is placed and this number is added to the total liability.

- Total assets must be equal to total liabilities plus total equity.

This leads to the balance sheet accounting formula: Assets = (Liabilities + Owner's Equity).

Statement of income

It is mainly dedicated to the expenses and income of an organization during a defined period of time. After expenses are subtracted from income, the state will generate an organization's profit amount, called net income.

Financial information for the prior period is presented together with financial results for the current period to facilitate comparison of performance over a period.

For example, if an organization is preparing the income statement for the six months ending December 31, 2018, the comparative figures for the prior period should relate to the six months ending December 31, 2017. The totals for the statement of income results are identified like this:

- Total of all income or sales for the period.

- Total of all expenses and operating costs of the business.

- Total expenses are subtracted from income to obtain the net income or profit for the period.

The general accounting formula for the income statement is: Net income = Total income - Total expenses.

Cash flow statement

There is no such formula for calculating a cash flow statement, instead it contains three sections that report the cash flow for the various activities in which a business has used its cash.

Examples

The following is an illustrative example of a balance sheet prepared for Company ABC:

An illustrative example of an income statement prepared for company ABC is as follows:

The following is an illustrative example of a cash flow statement prepared for Company ABC:

References

1. Chris Murphy (2019). Financial Statements. Investopedia. Taken from: investopedia.com.
2. Wikipedia, the free encyclopedia (2019). Financial statement. Taken from: en.wikipedia.org.
3. Accounting-Simplified (2019). What are Financial Statements? Taken from: accounting-simplified.com.
4. My Accounting Course (2019). What are Financial Statements? Taken from: myaccountingcourse.com.
5. Steven Bragg (2018). Financial statements. Accounting Tools. Taken from: accountingtools.com.
6. Inc (2019). Financial Statements. Taken from: inc.com.