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What is a financial statement?

A Financial statement is the financial information provided by the company to its stakeholders and outside world. This is done to present a concrete picture of how the company is faring in order to attract investors.

There are two types of financial statements: standalone and consolidated. Suppose that a parent company A has its subsidiaries P, Q and R. Then financial statements of company a combined with all of its subsidiaries P, Q and R are consolidated statements while financial statement of company an alone is its standalone statement.

What are the four basic financial statements?

The following are the four basic financial statements:

1)  Balance Sheet

2)  Profit and loss statement

3) Cash flow statement

4)  Retained earnings statement

These are described subsequently:

Balance Sheet: It gives financial information about a company's assets, liabilities and shareholders' equity at a given point of time. In simple terms, assets are what a company owns and liabilities are what it owes. The difference, Assets-Liabilities gives shareholders' equity. It gives the amount left with the shareholders if the company sells all its assets and pays off all its liabilities.

Profit and loss statement: It gives information about a company's income and expenses during a given period, generally for one financial year. Company earns by sale of goods, provision of services or other sources. Expenses are due to cost of goods or services, capital expenditure, salaries of employees and others.  The difference between income and expenses gives profit gained or loss incurred by the company.

Cash flow statement: It provides information about cash inflows and outflows of a company. Cash flow is due to three activities: operating, investing and financing. The term "cash" comprises cash in hand, balance with banks that can be retrieved on demand and cash equivalents.

Cash flow from operating activities: It is pertains to cash flows due to revenue generating activities.

Cash flow from investing activities: It pertains to cash flows due to acquiring or selling assets and investments.

Cash flow from financing activities: It pertains to cash flows due to raising funds and debt repayments.

Retained earnings statement: A company can distribute dividends and retain the rest of the income. It shows information on how retained earnings from the current period get added to the total retained earnings of the company and how dividends are paid.

What are the financial reports?

A financial report is a representation of how a company performed during a period (quarterly and annually). It is to present a picture of company's future plans and past performance to shareholders. It includes consolidated and unconsolidated financial statements.

What should be included in financial statements?

Different aspects of business are shown in the different financial statements. Let's look at them one by one:

Balance Sheet:

It includes equity and liabilities in one section and assets in the other. Under equity, share capital and reserves & surplus are mentioned. Liabilities are categorized as non-current liabilities and current liabilities. Non-current liabilities are long term in nature; that is they are to be settled after 1 year while current liabilities are due to be settled within the next 1 year. Examples of non-current liabilities are long-term borrowings and deferred tax liabilities. Current liabilities include short term borrowings and trade payables.

Similarly, assets are categorized into two categories namely current and non-current. Current assets are intended to be used within 1 year of reporting while non-current assets are long term in nature-to be held by the company for period more than 1 year. Non-current assets include fixed assets also-both tangible like building, machinery and non-tangible like patents and copyrights.  It also includes non-current investments and deferred tax assets. A typical list of current assets comprise inventories, cash and cash equivalents, current investments, trade receivables.

Profit and loss statement:

As mentioned earlier, it includes details of revenue and expenses. A company generates revenue from its operations and other sources like receiving rent from its building from other occupants. Expenses include cost of goods and services, operation expenses which further comprise administrative & general expense (A&G), repair and maintenance (R&M) and employee expense. Depreciation and amortization are also counted as expenses but they are not included in calculating actual cash flow. By subtracting expenses from revenue, profit before tax is calculated. Then current and deferred tax expenses are applied to get total tax incurred. The final outcome is profit and loss for the given period.

Cash flow statement:

In cash flow statement from operating activities, inflow is the sum of cash sales and credit sales whereas outflow is the sum of cash and credit purchase, operating expense and tax.

In cash flow statement from investing activities, inflow is the sum of sales of fixed assets and investments and interest and dividends received whereas outflow comprises purchase of fixed assets and investments.

In cash flow statement from financing activities, inflow is proceedings from short-term borrowings while outflow is debt repayment.

Retained earnings statement:

Outflow is calculated by subtracting dividends from sum of retained earnings till the beginning of the current financial year and net income of current financial year.

How do you write a financial report?

It is mandatory for a public company to publish its annual report while there is no such compulsion on privately held companies.

To write a financial report, performance of the company over a quarter or a year is assessed and future plans are laid. Introduction of board of directors and management teams, letters from CEO and chairman, performance summary, future plans for different divisions and subsidiaries of the company, management discussion and analysis (MDA), corporate governance report, consolidated and unconsolidated financial statements are all mentioned in the financial report. The financial statements are audited by a third party.

Guide for students who are not familiar with financial statement problems before:

  • Go through basics of accounting from good books and reliable internet sources.
  • Go through the basics of all the types of financial statements.
  • Download annual report of a company and study it completely. Don't go for banks initially since their financial statements are more complex.
  • Download financial statements of the company you are studying over the past 10 years. Make an excel sheet and try to recreate the formulae. For examples, try to calculate total assets by adding up its constituents, and then repeat the exercise for other components of financial statements. You can take the help of websites like yahoo finance and money control for downloading the financial statements directly in MSExcel.

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