Financial statements are the beacon for the performance of any company. By viewing a company’s performance through the lens of financial statements, you’ll be able to make informed decisions on how you deal with such companies.
Now, you should know that there are different types of financial statements. Each type helps the user, in a unique way different from another, to understand a company’s performance/position from a financial standpoint.
With that said, let’s get to the point:
What Are The Types Of Financial Statements?
There are five (5) types of financial statements:
- Statement of financial position,
- The income statement (Statement of profit or loss),
- Statement of cash flows,
- Statement of changes in equity, and
- Notes to the financial statements.
But before we delve deeper into each of them, it will help you a lot if you are first enlightened on the importance of financial statements for any business?
Financial statements show the state of finance in an organization: where the money comes from, how it is spent, where the money goes. The financial statement embodies everything about a company’s finances. And to prove the truth and fairness of the information provided in the statements, external auditors are obliged to pass an opinion on it at the end of each accounting year.
Financial statements may be prepared yearly, half-yearly, quarterly, bi-monthly, monthly or at intervals stipulated by the management.
Now let’s dive into the explanation of the 5 types of financial statements:
Statement Of Financial Position:
Formerly known as the balance sheet, the SOFP (Statement of financial position) shows the financial position at a particular point in time. The SOFP reveals information on the company’s assets, liabilities and equity.
The information in the SOFP must comply with the basic accounting equation, Assets = Equity + Liabilities. Nonetheless having equal balances on the SOFP does not mean no mistake has been made. This is why auditors are appointed to investigate and give an opinion before the SOFP is shared with other stakeholders.
These are resources under the control of an entity resulting from a past event that will result in the inflow of economic benefit to the entity. Examples of assets are land, building, inventory, copyrights, patents, inventory, etc. in the Statement of Financial Position, the assets are categorized as Non-current assets and Current assets. Assets are classified based on how quickly they can be converted into cash within 12 months. While inventory can be converted into cash within a year, non-current assets like buildings cannot be quickly flipped for cash within a year.
Non-current assets like buildings, motor vehicles and so on would be listed as inventory if the business trades such items in its ordinary course of business.
These are financial obligations on the neck of the company the settlement of which will result in the outflow of economic benefits from the entity. Examples of liabilities are account payables, debenture, loan notes etcetera.
This refers to the owners’ interest in the business. It is the leftover after deducting all liabilities from the company’s assets. It is also called Net Aset. equity includes Retained earnings, general reserves, ordinary share capital and the likes on the statement of financial position.
Formerly known as the statement of profit or loss and other income. The income statement reveals the profitability of a company over some time, usually the company’s accounting period.
The income statement shows the various income streams of the company and the various expenses incurred by the company. The income statement holds key information used in the computation of financial ratios like Earning Per Share, Dividend Per Share, Operating Profit Margin, Net Profit Margin and so on.
Here is a walkthrough of the income statement:
- Recognize the income earned from the Sales and less the Cost of Good Sold. The cost of goods sold is the cost of the items that have been disposed of, there you’ll have gross profit.
- From the gross profit, you will deduct other operating expenses like general administrative overheads, selling and distribution overhead and other relevant expenses that have been incurred in the process of operating the business i.e. rent, utility, travelling expenses, and so on.
- Ensure to deduct provisions such that of doubtful debt, you should also make allowance for depreciation and write off bad debts when necessary. These expenses are notional expenses as they do not result in the entity’s outflow of real cash.
The leftover after deducting all operating expenses is operating profit from which you will deduct finance costs like interests on bank loans.
Thereafter you will charge tax and voila, you have your profit after tax which will now be shared amongst shareholders depending on your entity’s dividend policy.
Statement Of Cashflow:
This shows the movement of money in and out of the entity. It does not show anything related to credit sales or purchases, just like the name implies, its only function is to show how “cash” flows in the entity.
The cashflow statement shows the liquidity of an entity. Being profitable is not the same as being liquid. As a business person, you’ll need to pay careful attention to your company’s liquidity because a lack of sufficient cash poses a huge threat to the going concern of your entity.
There are three activities in a typical statement of cashflow. They are:
- Operating activities,
- Investing activities and
- Financing activities.
Operating activities show the actual cash that was paid or received from the operation of the business. All notional expenses like depreciation are added back.
Investing activities refers to the purchase of assets with cash and monies generated from selling off any asset in the company’s investment bag.
Financing activities show cash flow in terms of borrowings to finance the company and the subsequent payment of such borrowing with its additional interest.
Statement Of Changes in Equity:
This is a detailed analysis of the equity shown in the statement of financial position. It shows how the equity structure of the firm changed during an accounting year. The transactions that will likely appear on the SOCIE are:
- Net profit or loss
- Dividend paid
- Retained earnings
- Proceeds from the sale of stock
- Gains and losses recognized directly in equity
- Effects of changes due to errors in prior periods
Notes To The Account:
Here, you will find a detailed explanation of various transactions that have been covered in the aforementioned financial statements. Preparing the notes to account helps users to gain better clarity on the accounting policies of the reporting entity.
I hope your understanding of the types of financial statements has improved after reading this article. Feel free to leave suggestions, questions, and reviews in the comment section.