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What Are the 4 Basic Financial Statements?

14 minute read

Are you ready to dive into the world of financial statements? Here we go!

The four basic financial statements are the balance sheet, the income statement, the statement of cash flows, and the statement of shareholder equity.

These statements are important for a number of reasons:

  1. They provide a snapshot of a company's financial position at a specific point in time. The balance sheet shows the company's assets, liabilities, and owner's equity, while the income statement shows the company's revenues and expenses over a specific period of time.
  2. They help stakeholders, such as investors and creditors, to understand the financial health of a company. By analyzing the financial statements, stakeholders can assess the company's ability to generate profits, pay its debts, and manage its cash flow.
  3. They help management to identify areas of strength and weakness within the company. By reviewing the financial statements, management can identify areas where the company is performing well and areas where improvements are needed.
  4. They are used to prepare financial projections and budgets. Financial statements can be used as a starting point to create forecasts and budgets for future periods.

Overall, the four basic financial statements are important tools for understanding a company's financial position, performance, and future prospects.

Balance Sheet

The balance sheet, also known as the statement of financial position, is a snapshot of a company's financial position at a specific point in time. It shows the company's assets, liabilities, and equity. Assets are resources owned by the company, such as cash, inventory, and equipment. Liabilities are obligations that the company owes to others, such as loans and taxes. Equity represents the residual interest in the assets of the company, which is the ownership interest of the shareholders.

Assets

Assets are resources that a company owns and are expected to provide economic benefits in the future. 

There are two main types of assets: current assets and noncurrent assets. Current assets are assets that are expected to be converted into cash or used up within one year or the company's operating cycle, whichever is longer. Examples of current assets include cash, accounts receivable, and inventory. Non-current assets are assets that are not expected to be converted into cash or used up within one year or the company's operating cycle. Examples of non-current assets include property, plant, and equipment, and intangible assets such as trademarks and patents.

It's important to note that the value of assets is not fixed and can change over time due to factors such as depreciation, amortization, and changes in market value. Understanding a company's assets can give you insights into its financial strength and ability to generate future cash flows.

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Liabilities

Liabilities are obligations that a company owes to others. 

There are two main types of liabilities: current liabilities and non-current liabilities. Current liabilities are obligations that are expected to be settled within one year or the company's operating cycle, whichever is longer. Examples of current liabilities include accounts payable, taxes payable, and short-term loans. Non-current liabilities are obligations that are not expected to be settled within one year or the company's operating cycle. Examples of non-current liabilities include long-term loans and leases.

It's important to note that the value of liabilities can change over time due to factors such as interest accrual, changes in exchange rates, and changes in market conditions. Understanding a company's liabilities can give you insights into its financial obligations and its ability to meet those obligations.

Shareholders Equity

Shareholders' equity, also known as shareholder equity or owners' equity, represents the residual interest in the assets of a company. It is the portion of the company that is owned by the shareholders and represents the difference between a company's assets and liabilities. 

Shareholders' equity consists of two main components: capital stock and retained earnings. Capital stock represents the funds that shareholders have invested in the company through the purchase of stock. Retained earnings are the profits that the company has earned and retained over time, rather than distributing them as dividends to shareholders.

Example of a Balance Sheets

Here is an example of a balance sheet for a fictional company called ABC Corporation:

ABC Corporation Balance Sheet As of December 31, 20XX

Assets Current Assets: Cash and cash equivalents: $50,000 Accounts receivable: $70,000 Inventory: $40,000 Total current assets: $160,000

Non-current Assets: Property, plant, and equipment: $200,000 Intangible assets: $100,000 Total non-current assets: $300,000

Total assets: $460,000

Liabilities Current Liabilities: Accounts payable: $40,000 Taxes payable: $20,000 Short-term loans: $30,000 Total current liabilities: $90,000

Non-current Liabilities: Long-term loans: $100,000 Leases: $50,000 Total non-current liabilities: $150,000

Total liabilities: $240,000

Shareholders' Equity: Capital stock: $100,000 Retained earnings: $120,000 Total shareholders' equity: $220,000

Total liabilities and shareholders' equity: $460,000

This balance sheet shows that ABC Corporation has total assets of $460,000, made up of $160,000 in current assets and $300,000 in non-current assets. The company also has total liabilities of $240,000, made up of $90,000 in current liabilities and $150,000 in non-current liabilities. The company's shareholders' equity is $220,000, made up of $100,000 in capital stock and $120,000 in retained earnings. This balance sheet indicates that the company's assets are financed through a combination of debt (liabilities) and equity (shareholders' equity).

Income Statements

The income statement, also known as the profit and loss statement, shows a company's revenues and expenses over a specific period of time, such as a month or a year. The income statement shows whether the company has made a profit or a loss during that period.

Revenue

Revenue is the total amount of money that a company generates from the sale of goods or services during a specific period of time, such as a month or a year. It is typically the top-line item on an income statement, which is a financial report that shows a company's revenues and expenses over a specific period of time.

Expenses

Expenses are the costs that a company incurs in order to generate revenue. They are typically subtracted from revenue on an income statement, which is a financial report that shows a company's revenues and expenses over a specific period of time. The resulting number is the company's profit or loss for the period.

Example of Income Statements

Here is an example of an income statement for a fictional company called ABC Corporation for the year ended December 31, 20XX:

ABC Corporation Income Statement For the Year Ended December 31, 20XX

Revenue: Sales: $1,000,000 Other revenue: $100,000 Total revenue: $1,100,000

Expenses: Cost of goods sold: $600,000 Selling, general, and administrative expenses: $200,000 Depreciation and amortization: $100,000 Interest expense: $50,000 Total expenses: $950,000

Income before tax: $150,000 Income tax expense: $31,500 Net income: $118,500

This income statement shows that ABC Corporation had total revenue of $1,100,000 for the year ended December 31, 20XX. This revenue was made up of $1,000,000 in sales and $100,000 in other revenue. The company also had total expenses of $950,000, which included costs such as cost of goods sold, selling, general, and administrative expenses, and depreciation and amortization. The company's income before tax was $150,000, and after accounting for income tax expense, its net income was $1118,500. Net income represents the company's profit for the year and is the amount available to be distributed to shareholders as dividends or retained by the company for future growth.

Cash Flow Statements

The statement of cash flows shows how a company has managed its cash during a specific period of time. It shows the cash inflows from activities such as selling goods or services, and the cash outflows from activities such as paying bills and making investments.

Operating Activities

Operating activities on a cash flow statement refer to the inflows and outflows of cash that are related to a company's main business operations. These activities include the sale of goods or services to customers, the purchase of inventory and supplies, and the payment of expenses such as salaries and rent.

Investing Activities

Investing activities on a cash flow statement refer to the inflows and outflows of cash that are related to a company's investments in long-term assets such as property, plant, and equipment, as well as investments in securities such as stocks and bonds. These activities include the purchase and sale of these assets, as well as the receipt and payment of dividends from investments.

Financing Activities

Financing activities on a cash flow statement refer to the inflows and outflows of cash that are related to a company's financing activities, such as the issuance of debt or equity securities, the repayment of debt, and the payment of dividends to shareholders.

Example of Cash Flow Statement

Here is an example of a cash flow statement for a hypothetical company called ABC Corporation:

Cash Flow Statement for the year ended December 31, 20XX

Cash flows from operating activities:

  • Net income: $100,000
  • Adjustments to reconcile net income to net cash provided by operating activities:
    • Depreciation: $20,000
    • Gain on sale of equipment: ($5,000)
    • Increase in accounts receivable: ($15,000)
    • Increase in inventory: ($10,000)
    • Increase in accounts payable: $25,000
    • Decrease in income taxes payable: $10,000
    • Decrease in other current assets: $5,000
  • Net cash provided by operating activities: $90,000

Cash flows from investing activities:

  • Purchase of property, plant, and equipment: ($50,000)
  • Proceeds from sale of equipment: $10,000
  • Net cash used in investing activities: ($40,000)

Cash flows from financing activities:

  • Proceeds from long-term debt: $50,000
  • Repayment of long-term debt: ($30,000)
  • Dividends paid: ($20,000)
  • Net cash provided by (used in) financing activities: $0

Net increase in cash and cash equivalents: $50,000 Cash and cash equivalents at beginning of period: $100,000 Cash and cash equivalents at end of period: $150,000

Shareholders Equity

Shareholders' equity, also known as shareholder equity or owners' equity, represents the residual interest in the assets of a company. It is the portion of the company that is owned by the shareholders and represents the difference between a company's assets and liabilities. 

Shareholders' equity consists of two main components: capital stock and retained earnings. Capital stock represents the funds that shareholders have invested in the company through the purchase of stock. Retained earnings are the profits that the company has earned and retained over time, rather than distributing them as dividends to shareholders.

Example of Owner's Equity

Here is an example of a Owner's Equity statement for a hypothetical company called ABC Corporation:

Statement of Owner's Equity for the year ended December 31, 20XX

Owner's equity at beginning of period: $500,000

Additions:

  • Net income for the year: $100,000
  • Investment by owner: $50,000

Total additions: $150,000

Deductions:

  • Withdrawals by owner: ($20,000)
  • Dividends paid: ($30,000)

Total deductions: ($50,000)

Owner's equity at end of period: $600,000

This owner's equity statement shows that the company had owner's equity of $500,000 at the beginning of the year, and it increased by $150,000 during the year due to net income and additional investments by the owner. The owner also withdrew $20,000 and the company paid $30,000 in dividends, which reduced the owner's equity by a total of $50,000. As a result, the owner's equity at the end of the year was $600,000.

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