What is a Financial Statement?

Financial statements are written records of an organization which provide a true and real picture of business activities. It shows the financial position and the operating performance of the company. It is prepared at the end of every financial cycle. It includes three main components that are balance sheet, income statement and cash flow statement.

Components of a Financial Statement

Components of financial statements are the part of the financial statement which are prepared and these together are called the components of financial statements each component helps in understanding the financial operation and position of the business. Let us know these components in detail:

• Balance sheet: This statement records all the assets liabilities and shareholder’s equity of a business at a specific period of time. It records all these items in summarized way. Balance sheet shows a true financial position of the business means it shows where a company is standing at given point of time. It shows the worth of the business.

Items of the balance sheet

Assets

Assets part of the balance sheet shows what a business owns at a particular time which have a value and can be converted into cash. All the assets are recorded in the balance sheet according to their liquidity. Liquidity means how easily and quickly the assets can be converted into cash. Asset part of the balance sheet is divided into two categories and that are current assets and current liabilities

• Current assets: Current assets are those assets which can be converted into cash more quickly and easily within a short period of time that is 1 year. Or this period can depend upon the company’s own way of treatment. Current assets are divided into various parts and these are cash and cash equivalent, marketable securities, inventory and prepaid expenses. Items of cash and cash equivalent are the most liquid assets which include currency, checks saving accounts, etc. Marketable securities include those investments which can be sold within a year. Inventory of business include raw material and finished goods.
• Non-current assets: another part of the asset is non-current asset it is also termed as long term assets. This part is break down into fixed assets, long term securities and intangible assets. Fixed assets include items like machinery, building furniture etc. Long term securities include the investments which cannot be sold within a year. Intangible assets include those assets which do not have physical existence like copyrights, goodwill, patents.
• Liabilities: The next part of the balance sheet the liabilities side. This includes all the liabilities of the business. Liabilities of the business refer to all the money which a business owes to others. Liabilities part is further divided into two sections, short term liabilities and long term liabilities. Short term liabilities are those liabilities which can be paid off within a year and this includes items like rent, taxes, interest payments, etc. Long term liabilities are those liabilities which cannot be paid off within a year such as long term loan, deferred tax, long term provision etc. 
• Shareholder’s equity: Another item of balance sheet is the shareholder’s equity. Shareholder’s equity means the total amount of money which is generated by the company, means the amount which are invested into the business by the shareholders. It is the net assets of the company. The formula of calculating this is total asset – total liabilities.

The balance sheet is divided into two parts one is asset side and other is liabilities and shareholder equity. Value of both the parts must be equal as the name balance sheet suggests that both the part must be balanced.  

Format of a balance sheet

• Income statement: Next component of financial statements is income statement. It shows the income generated by the company at a given point of time. It records the total revenues and expenses and net profit or loss of the company. It shows the clear picture of the profitability and the operating of the business. It does not show that how the income of a company is generated it just shows the expenses incurred to generate the revenue. It is also known as statement of profit and loss account.

 Some of the items included in income statement are:

Revenue and sales: The first item in an income statement is revenue or sales it includes the revenue that a company earns by selling its products or services.

Cost of goods sold: Cost of goods sold means the total direct expenses incurred in order to sell the product and services, this includes labor cost material cost.

Gross profit: Gross profit is the difference between the total costs of goods sold and total revenue.

Advertisement expenses: It is an indirect expense which is associated with the marketing.

Depreciation expenses: it is also an indirect expense which is charged on the long term asset of the business. It is shown on the expense side of the income statement.

Earning before tax: it is the net income before the deduction of tax it is the second last item of the income statement.

Net income: It is the final and last item of the income statement which is calculated by deducting total indirect expenses and direct expenses from total direct and indirect income.

Cash flow statement: Third major component of the financial statement is cash flow statement it is cash flow statement; it is also known as statement of cash flow. It records inflow and out flow of cash means how much cash is coming into the business and how much is going out of the business. It shows the changes in cash of the business at a specified time period. It is one of the three most important statements which ensure a business have enough cash for operating the business smoothly. It tells you how much cash you have in your hand for a specific period of time.

Objective of a Financial Statement

• Financial statements are required to know whether the company is earning adequate profit or its capacity to earn profits. So that shareholders and investors can use this data to make their financial decisions.
• It also helps to analyze the position of the business as regard to the capacity of the entity to repay its long term as well as short term liabilities.
• Financial statements also provide necessary data and information for taking proper decisions relating to price control, taxes, duties etc. and for some legal purposes.
• By making a comparative study about the profit of the company with the other company engaged in the same business, financial statement help the management to take the corrective steps well in advance and can adopt sound business policy by making intra firm comparison.
• Financial statements provide data and information regarding the weak spots of the business so that corrective measures can be taken to eliminate those.

Context and Applications

This topic is significant in the professional exams for both undergraduate and graduate courses, especially for 

• B.B.A in Accounts  
• M.B.A in Accounts