MaRS Library Financial statements: Balance sheet and income, retained earnings and cash flow statements
Financial statements describe the profitability and value of a business. Four components make up a standard set of financial statements:
1. Balance sheet
In short, this is the critical“what do we have” statement. The balance sheet shows what the company owns, and what the company owes (these two amounts are always in balance [see the fundamental accounting equation]). Any remaining difference between these two amounts shows what belongs to the owners as their interest. This document is a permanent statement—its numbers present an aggregate of the company’s financial history from the day the company began up to the present. When reading a balance sheet, you can find key information in the working capital, fixed assets and owners’ (shareholders’) equity.
2. Income statement (also known as the profit and loss statement)
In short, this is the“what did we do” statement. This document shows how the company performed during its course of operations during a fixed period of time. Unlike the balance sheet, the income statement is a temporary statement. It accumulates information over a set period (usually monthly or quarterly) at the end of which its numbers are reset to zero in order to start tracking activity of the next period. Key elements of the income statement include revenue and expenses. Combined, these numbers yield the net income (or loss).
3. Statement of retained earnings
The statement of retained earnings shows the changes in retained earnings over the course of the tracking period. Why is the statement of retained earnings important? It is a measure of the assets of your operation that have been generated through profitable activity, retained in your business and not paid out to shareholders as dividends. Stakeholders (such as investors or potential investors) in your company will be interested in reading this statement to better understand how their (potential) dividends compare to your reported profits. Generally, a large amount of retained earnings is regarded as a sign that the company has done well and is reinvesting its profits in itself. Keep in mind though, that a young company often faces reporting negative retained earnings as it takes time to build the business and become profitable.
4. Statement of cash flow
The statement of cash flow shows details about the cash that moved through the business during the tracking period—how it came in, and how it left. Money can come into the company through channels such as operating income, sale of assets or equity or by borrowing funds. Or it can leave, for example, through operating losses, purchase of assets, or paying off of loans or interest. The statement of cash flow does not contain new information in the financial statement—it is derived from what is provided on the balance sheet and income statement. This statement of cash flow informs investors and creditors about the solvency of your business.
Markle, K. (2004, August). Introduction to Accounting. Presentation delivered at Schulich School of Business, York University, Toronto, Canada.
Plant, Albert C. (2007). The retail game: playing to win: a guide to the profitable sale of goods and services. Vancouver: Douglas & McIntyre Ltd. pp. 213-220.
Pratt, Jamie. (2003). Financial Accounting in an Economic Context. New York: John Wiley & Sons.