What Do Financial Statements Show?
The purpose of a firm’s financial statements is to provide an overview of the financial activity and health of the organization. For purposes of taxation, finance, or investment, as well as to assure accuracy, accountants and government agencies frequently conduct audits of financial accounts.
Balance sheets, cash flow statements, income statements, and statements of changes in equity are the main financial documents used by for-profit enterprises. Despite their name changes and other informational differences, nonprofits employ the same basic set of financial statements as for-profit businesses.
A Brief Overview of Financial Statements
Internal and external stakeholders alike utilize financial data to assess a company’s health and forecast its stock price movement. The annual report, which includes the audited financial statements of the company, is a crucial source of trustworthy financial information.
Creditors, investors, and market analysts all analyze the financial statements to get a feel for the company’s financial situation and future profits. There are three main reports that make up financial statements: the income statement, the balance sheet, and the statement of cash flows.
The accounting standards used to compile various financial statements might vary. International Financial Reporting Standards (IFRS) are the regulations that many foreign corporations employ, whereas Generally Accepted Accounting Principles (GAAP) are the rules that American companies use. In addition, there is a distinct set of regulations governing financial reporting by US government entities.
A Complete Guide to Balance Sheet Analysis
The balance sheet is an accounting document that summarizes the liabilities, assets, and shareholders’ equity of a business as of a certain date. The balance sheet’s top date indicates the time of this snapshot, which is usually the conclusion of its yearly reporting period. What follows is an explanation of what a balance sheet contains.
1. Assets
- Liquid assets include cash and its equivalents, which might include things like certificates of deposit and Treasury bills.
- For any business, the sum due from clients for goods and services rendered is accounts receivable.
- Inventory refers to the items that a corporation keeps on hand with the intention of selling them during commercial operations. Finished goods, unfinished WIP, and raw materials on hand are all examples of inventory items.
- The term “prepaid expense” refers to outlays made before the due date. For the time being, we are treating these costs as an asset rather than a liability. If the benefit were to go unrecognized, we might possibly get a return for them.
- The capital assets that a business owns for the benefit of the future are known as property, plant, and equipment (PPE). Included in this category are structures that house factories or large pieces of equipment that process raw materials.
- An investment is any asset that one holds with the expectation of future growth. Not used in activities, but kept for potential capital gain.
- It is impossible to put a price on intangible assets like goodwill, patents, and trademarks, yet these assets can bring in money for the business in the future.
2. Liabilities
- In the course of doing business, several invoices will inevitably become due, and these bills are known as accounts payable. Invoices for utilities, rent, and raw material purchases fall within this category.
- All employees are owed their wages for the period they have worked.
- Debt documents known as notes payable document official debt arrangements, including the amount and payment period.
- Declared dividends to shareholders that have not been paid yet are known as dividends payable.
- Many types of debt have maturity dates longer than a year away, such as mortgages, sinking bond funds, and other types of long-term loans.
- In contrast to long-term debt, short-term debt is an immediate burden.
3. Equity for Stockholders
- The difference between a company’s total assets and its entire liabilities is known as shareholders’ equity. Stockholders’ equity, or shareholders’ equity, is the sum that would remain after paying off all obligations and liquidating all assets.
- What remains after paying dividends to shareholders is known as retained profits, and it is a component of shareholders’ equity.
Financial Statement Example
The following is an excerpt from the fiscal year 2023 financial statement of ExxonMobil Corporation (XOM), as reported on December 31, 2023.
There were $376.3 billion in total assets.
There were a total of $163.8 billion in liabilities.
There were $212.5 billion in total equity.
The sum of all assets and liabilities during the time was $376.6 billion.
Making Sense of the Income Statement
The income statement, in contrast to the balance sheet, typically covers a year or quarter’s worth of financial data. The income statement summarizes the income, expenditures, net income, and EPS for that period.
Although the income statement’s primary function is to report a company’s profitability and the monetary outcomes of its operations, it also serves as a useful tool for executives and managers by revealing, through comparison of different time periods, whether sales or revenue is growing.
To gauge the potential long-term impact of cost-cutting initiatives on profitability, investors might also look at how efficiently management is handling spending.
1. Revenue
There are three main types of revenue: operational, non-operating, and other.
A business’s operational income is the money it makes by selling its goods and services. The production and sale of automobiles would provide operational revenue for a car manufacturer. The primary operations of a firm are the ones that bring in operating revenue.
Revenue that does not directly relate to running the firm is known as non-operating revenue. These earnings are unrelated to the core operation of the company. Earnings from sources other than operations include:
- Interest paid on funds held in a savings account
- Rental of real estate
- Partnerships with a strategic focus, such as royalty payment receipts
- Advertising billboards situated on the premises of the business
- The term “other income” refers to monies that come in from sources other than investing. Sale profits of land, cars, or a wholly owned subsidiary are examples of long-term assets that could contribute to additional revenue.
2. Expenses
First and foremost, a company has to pay its fundamental expenditures before it can turn a profit from its main operation. Costs encompass:
- The cost of goods sold (COGS)
- Sales, general, and administrative costs
- Amortization or depreciation
- Research and development (R&D)
- Typical costs include paying employees, getting sales fees, and paying for things like transportation and energy.
- Interest on loans and other forms of debt are examples of expenses associated with secondary activity. Another type of expenditure is the loss that results from selling an asset.
Income Statement Example
The following is an excerpt from the income statement for the fiscal year 2023 of ExxonMobil Corporation, as reported on December 31, 2023.
$344.6 billion was the total revenue.
Expenditure amounted to $291.8 billion.
The total profit or net income was $36 billion.
A Guide to Cash Flow Statement Analysis
A company’s revenue and expenses are detailed in the cash flow statement (CFS). The income statement, balance sheet, and cash flow statement all work together.
With the help of the CFS, investors may see how a business is doing operationally, as well as the sources and uses of its revenue. A company’s financial health can be better understood with the help of the CFS.
There are three parts to the cash flow statement that detail the many ways a business spends its money.
1. Functional Operations
Any money coming into or going out of the company as a result of selling goods or services is considered operational activity on the CFS. Changes in cash from operations include any modifications to:
- Depreciation
- Cash accounts receivable
- Accounts payable
- Inventory
- Wages, rent, interest payments, and cash from the sale of a good or service are also examples of these kinds of exchanges.
2. Investment-Related Activities
Whatever a business does with the money it earns from investments—whether it’s buying new equipment, selling off old assets, or making further investments—in its long-term future is considered an investment. Things like:
- The exchange of one asset for another
- Funds borrowed from clients or given to suppliers
- Merger or acquisition-related payments
- Spending on PPE, or property, plant, and equipment
- Finance-related operations
- Investment or bank funds, as well as distributions to shareholders, are all part of the cash flow from financing operations. Financial operations encompass:
- Issuing of debt
- Issue of stock
- Buybacks of stocks
- Money Advances
- Dividends paid
- Repayment of debt
For three main company operations, the cash flow statement bridges the gap between the income and balance sheets.
An Illustrative Cash Flow Statement
The following is an excerpt from the cash flow statement for the fiscal year 2023 of ExxonMobil Corporation, as reported on December 31, 2023. All three parts of the cash flow statement are visible, along with the outcomes of each.
Of the $55.4 billion in cash flow, $55.4 billion came from business operations. There was a negative $19.3 billion cash outflow for the time due to investing. The bulk of the cash outflows were for improvements to property, plant, and equipment, indicating that the business invested in new fixed assets. The period’s cash outflows were $34.3 billion due to financing operations. The majority of the monetary outflows came from shareholder dividends and the purchase of common stock.
Making Sense of the Statement of Equity Changes
You can see how total equity has changed over time in the statement of changes in equity. If you look at the balance sheet for the same time period, you’ll see that the ending balance of the change of equity statement is equal to the total equity recorded there. Stockholders and potential investors rely on this data to gain insight into a company’s financial health.
Companies’ specific formulas for calculating changes to shareholder equity will differ, but in general, they include the following:
- Starting equity: This is the equity from the previous period that carries over to the beginning of the current period.
- (+) Net income: The sum of money that a business made within a specific time frame. At the end of the year, the money that comes from operations is automatically turned into stock in the firm and put into retained profits.
- (-) Dividends: This is the portion of earnings distributed to shareholders. Companies often distribute a portion of their earnings to investors rather than retaining the whole amount for themselves.
- (-) Other comprehensive income: The change in other comprehensive income from one period to the next. This number can represent an increase or decrease to equity, depending on the nature of the transactions.
A variety of financial transactions, including sales, purchases, and the amortization of stock-based awards are included in ExxonMobil’s statement of changes in equity. Instead of dispersing funds to other parties, this data might help you see how much capital is staying in the firm for expansion.
How to Read the Statement of Comprehensive Income
The comprehensive income statement is an underutilized financial document that, in addition to summarizing conventional net income, also accounts for changes in additional comprehensive income (OCI). The term “other comprehensive income” refers to any and all profits and losses that have not yet been realized and are not shown on the income statement.
All income changes, including gains and losses not yet recorded in accordance with accounting standards, are shown in this financial statement. Lenders and investors can utilize this data to acquire a fuller view of the financial health of a business.
The statement of comprehensive income includes the following types of transactions:
- Unrealized gains or losses from debt securities
- Net income (from the statement of income)
- Unrealized translation adjustments due to foreign currency
- Unrealized gains or losses from derivative instruments
- Unrealized gains or losses from retirement programs
ExxonMobil has a net unrecognized income of more than one billion dollars. After adjusting for other comprehensive income, ExxonMobil’s reported net income is really $37.3 billion, not $36 billion.
Accounts of Nonprofit Organizations
All nonprofits use the same set of financial documents to track their money coming in and going out. Nonprofits, on the other hand, do not pay out profits and do not have shareholders. Consequently, businesses record their transactions, earnings, and expenditures through different financial statements.
Those who make use of these financial reports include:
- Donors, to evaluate a nonprofit’s operations prior to donating
- Internal or external auditors, to check that a nonprofit is making good use of its fundraising dollars
- Government entities, in order to guarantee that a charitable organization satisfies all tax and legal criteria
1. Financial Position Statement
This resembles the balance statement of a business that operates for profit. One key distinction is that nonprofits do not have any kind of equity stake. After paying off all debts and liquidating all assets, the remaining amount is known as “net assets.”
2. Activities Statement
This document serves as the monetary equivalent of a profit and loss statement for a business. Donations, grants, event income, and operational expenditures are all included in this report, which follows the evolution of the business over time.
3. Functional Expense Statement
Only nonprofit organizations make use of this report. It is common practice to categorize an entity’s spending on administrative, programming, and fundraising costs separately in the statement of functional expenses. Shared with the public, this data illustrates the percentage of total corporate spending that supports the nonprofit’s objective.
4. Cash Flow Statement
This document serves the same purpose as a cash flow statement for a for-profit business. There are three sections to the statement: investing, operating, and financing. The specific accounts mentioned may change since nonprofits differ from one another, but overall the structure is the same.
5. The Financial Statements’ Limitations
There are limits to the information that financial statements may provide about a corporation, notwithstanding their usefulness. As a result of differing interpretations of the statements, investors frequently arrive at different judgments regarding the financial success of an organization.
Consider the case of investors who would rather see their money put into long-term assets than stock repurchases. One investor may have no problem with a company’s debt level, while another may have reservations.
It is essential to compare the company’s performance to that of its competitors in the same sector and to compare the results from different time periods in order to identify patterns when evaluating financial statements.
Finally, the accuracy of financial statements is directly proportional to the quality of the data used to generate them. All too frequently, it has been proven that fraudulent financial behavior or inadequate control supervision has resulted in misleading financial statements that were meant to deceive users. Users must have some faith in the reliability of the report and the presented data, even when examining audited financial records.
If an organization has hired an external auditor, they will check the financial accounts to see if they follow GAAP. Investors, lenders, and others will have an easier time understanding financial reports if all firms are using the same format. In addition, independent auditors check that there are no intentional or unintentional errors or omissions in these financial accounts.
Which Financial Statement Types Are the Most Common?
The balance sheet, income statement, and cash flow statement are the most common forms of financial reporting. A company’s assets, liabilities, income, and expenses, as well as its cash flows from operations, investments, and financing are all detailed in the three financial statements.
Why Are Financial Statements Useful?
Accounting records reveal the inner workings of a company. They show the several ways a company makes money, the kind of money it makes, how well it handles its money, and what assets and liabilities it has. A company’s financial statements reveal the level of management quality.
Financial Statements: How Can You Interpret Them?
Various methods exist for interpreting financial statements. To begin, changes throughout time can be better understood by comparing current and previous periods’ financial accounts. Another way to examine how different companies in the same industry are doing financially is to compare their financial statements. Analysts may learn a lot about a company’s performance relative to its competitors by comparing its financial statements to those of other firms in the same industry.
How Does GAAP Work?
Financial statements for publicly traded corporations in the US must adhere to GAAP, or Generally Accepted Accounting Principles. Here you will find the rules that dictate when and how to record transactions, as well as when income and costs should be acknowledged. Worldwide businesses have the option to utilize IFRS, or International Financial Reporting Standards, which are comparable yet unique.
How do you analyze financial statements?
In order to make informed business decisions, financial statement analysis involves reviewing and evaluating a company’s financial accounts. Stakeholders from the outside can use it to gauge the company’s general health, as well as its financial performance and worth. Internal members use it as a way to keep an eye on how the finances are being managed.
A Guide to Financial Statement Analysis
A company’s financial statements provide crucial financial information about the company’s operations. To that end, we can assess them according to their actual, expected, and predicted results.
The foundation of most financial accounts is GAAP, or US generally accepted accounting standards. In accordance with these guidelines, a business must compile and keep track of three primary financial statements: the income statement, the balance sheet, and the statement of cash flow. The reporting requirements for financial statements of publicly traded corporations are more stringent. Adherence to GAAP necessitates accrual accounting for publicly traded corporations.
When it comes to preparing their financial statements, private enterprises have more leeway to choose between accrual and cash accounting methods.
Financial statement analysis often makes use of a number of methods. Ratio analysis, horizontal analysis, and vertical analysis are three of the most fundamental methods. Through the study of line item values over two or more years, horizontal analysis examines data horizontally. Vertical analysis looks at how line items affect other elements of the business and the overall size of the business. As a statistical tool, ratio analysis relies on key ratio measures to determine correlations.
Financial Performance
Every day, businesses compile and analyze their financial accounts for internal management purposes. When it comes to keeping the company running and gauging its overall financial success, stakeholders both inside and outside the company typically employ the same corporate finance approaches.
In order to do horizontal analysis, analysts usually employ data from numerous years when undertaking complete financial statement analysis. Vertical analysis is also used to each financial statement in order to better understand the impact of the various statement categories on the results. Last but not least, ratio analysis may be employed to collect data from several statements and extract specific performance measures from each.
A few of the most popular ratio measures are outlined below:
- On the balance sheet, you can see the days to sales, the quick ratio, the asset turnover, the receivables turnover, the debt-to-assets ratio, and the debt-to-equity ratio.
- Included in the income statement are the following metrics: interest coverage, tax ratio efficiency, net profit margin, operational profit margin, and gross profit margin.
- Cash flow comprises cash and EBITDA (earnings before interest, taxes, depreciation, and amortization). You may see these numbers broken down by share.
- A comprehensive approach that incorporates DuPont analysis, return on equity (ROE), and return on assets (ROA).
What are the pros of analyzing financial statements?
Examining the income statement, balance sheet, and statement of cash flow is the backbone of financial statement analysis, which aims to assess the worth and performance of a business. Multiple methods, including ratio analysis, vertical analysis, and horizontal analysis, can help investors understand a company’s financial profile better.
How can one go about analyzing financial statements?
Analysts often examine a company’s financial accounts using three primary methods.
A comparison of past data is the first step in horizontal analysis. Looking for patterns of growth across several time intervals is the usual goal of horizontal analysis.
The second type of financial statement comparison is known as “vertical analysis.” An expenditure item, for instance, may be stated as a percentage of the total sales of the firm.
As a last step, ratio analysis examines line-item data and is an integral aspect of fundamental equity research. A few examples of ratio analysis include price-to-earnings (P/E) ratios, earnings per share, and dividend yield.
What does financial statement analysis look like in real life?
An analyst’s first step in assessing a company’s profitability and value creation efficiency is to examine its income statement using a variety of ratios. To illustrate the disparity between sales and COGS, one might look at the gross profit margin. It can be a good indicator for the company’s future if its gross profit margin is larger than its competitors. While doing so, the analyst may use a horizontal analysis of the company’s operational patterns to note that the gross profit margin has been rising over the last nine fiscal quarters.
In Conclusion
In order to conduct an independent assessment of a business’s financial health, one must have access to its financial statements. The income statement shows how profitable a business is, whereas the balance sheet shows how solvent and liquid it is. A cash flow statement connects the two by detailing the inflow and outflow of funds. Accounting professionals, investors, regulators, and lenders all rely on these financial statements to obtain an understanding of a company’s health.
