Types of Financial Statements

The types of financial statements refer to the different kinds of records in a written format that depict the transactions a company carries out over a period, thereby helping the management and investors of the firm assess its performance for better and more effective decision-making.

Though there are multiple types of financial statements that an organization or entity has, there are three of them that are necessarily maintained by every business firm. These include the balance sheet, income statement, and cash flow statements. These written records facilitate analyzing and comparing an organization’s financial position and performance.

The types of financial statements maintained by businesses and entities are many with the transactions recorded in different forms. These enable information readers to understand how fruitful the performance of a firm has been over a period. Given the revelations the figures make, the management determines strategies to improve their functioning and implement better strategies to become better or at least work on keeping up the same pace if it’s yielding good results.

The financial statements, in addition, also allow investors to have a look at the performance of the businesses and analyze their future prospects. If the performance is observed to be on the right track, the investors trust the company, or else they look for other businesses to make investments. The most common types of these statements that firms necessarily use include the following:

1. Balance Sheet: A balance sheet tells information readers where the company stands in terms of assets and liabilities.
2. Income statement: With an income statement, one comes to know about the performance of every single income stream of a company.
3. Cash flow statements: As the name suggests, cash flow statements are meant to mention the actual cash flow so that the real scenario is clear.

The above financial statements are prepared in various forms to serve certain objectives. Some of these purposes include:

• They reflect the figures, indication assets, liabilities, revenue, expenses, and cash flows derived from different business activities.
• The income statement tends to enable businesses to analyze latest trends with respect to the business operations being carried out.
• The balance sheet is prepared to tell information readers about the status of any business as of the mentioned date on the statement. This indicates the current funding, liquidity, and debt position of a firm.
• The cash flow statement, on the other hand, is maintained to identify different means of payments received and disbursed for various activities.

The three types of statements have already been introduced above. However, they have been explained in detail with examples below. Let us have a look at them:

#1 Balance Sheet

It is one of the type of financial statements considered as a final output for all financial statements as the net profit from the income statement and ending cash balance from cash flow statements are inputs for creating a balance sheet. It shows all the assets and liabilities & shareholders equity of the company. According to the balance sheet equation:

Assets = Liabilities + Shareholder’s Equity

Example of Balance Sheet

In balance sheet on the side of Assets in Accounting, we have the following items:

• Cash and Cash Equivalents: The amount of money that the company holds as cash and bank balance.
• Marketable Securities: The Company can also park investment in mutual fund schemes, debentures, public stock/private investment in other companies to earn for the short term.
• Account Receivables: It is the claim of the company against all the credit-based sales done by it to the clients.
• Inventory: It is the main product and services which the company wants to sell.
• Plant & Equipment: It includes all the equipment which the company uses to build its products.

On the Liabilities side of the Balance sheet, we have the following items:

• Accounts Payables: The total claims that others have on our company as we purchase their goods and services on credit.
• Unearned Revenue: When a customer pays in advance, but the product is not yet delivered to him when we say that this revenue is yet to be earned, and hence it becomes a liability on our balance sheet.
• Current Portion of Long Term Debt: It shows that part of the debt we need to retire this year itself.
• Long Term Debt: It shows all the long term borrowings of the company, which we will repay over a long course of time as and when they come due.

On the Equity side of the Balance sheet, we have the following items:

• Paid Up Capital: It shows the original capital, which the owners of the business invested, and follows on the increase in capital if more shares were issued.
• Retained Earnings: It provides an insight into the money the business has made over time but has kept it with itself rather than sharing it with investors by way of dividends.

#2 Income Statement

The income statement is one of the types of financial statement that stores all the company's income and expenditures. As the business does its day-to-day business, it keeps on incurring daily expenses and earning income from its business activities. All these items are recorded in this statement. We earn our income by selling our products and providing services to the client. There can be a variety of expenses that the company can incur, some of which are mentioned below:

• Salaries
• Rent
• Telephone & Internet
• Water & Electricity
• Taxes
• Insurance
• Advertising & Marketing Cost
• Fuel
• Stationary
• Interest Paid and Other Bank Charges

Above is the list of expenses, and this list is not conclusive.

Example of Income Statement

Below is a typical example of the Income statement:

We start by reporting our overall sales from the business. Then we subtract the cost of producing those goods and services to get the business's gross margin. Now we subtract all the business-related expenses (like those mentioned above) to calculate Operating earnings (EBITDA). Then we subtract depreciation and amortization (D&A) to calculate final operating earnings (EBIT). Finally, from EBIT, we will reduce Interest to get Earnings before tax (EBT) / Profit before tax (PBT), and then we will deduct taxes to calculate the final figure of Profit after tax (PAT).

#3 Cash Flow Statement

This statement is one of the types of financial statements that records all-cash transactions that have happened over the period in the business. There are some ways by which the books of account can be window dressed to look better than what they should be, but manipulating cash is very difficult. Hence, a cash flow statement is considered a more reliable source of information. A company primarily generates cash from 3 areas:

• From its operations: which is covered in cash flow from operating activities.
• From the purchase and sale of its assets: which is covered in cash flow from investing activities;
• From raising funds via debt and equity: which is covered in cash flow from financing activities;

Example of Cash Flow Statement

Within Cash Flows from Operations, we start from Net Income and then reduce all the non-cash expenses like depreciation and add back all the non-cash gains in Net Income. Then, we add back all the decrease in current assets as they would have reduced our asset balance initially, and hence we should add them. Similarly, we need to subtract all increases in the current asset as an investment in the current asset would have reduced our asset pool, so we should add it back. We will do just the opposite on the liabilities side to back-calculate the cash flow from our business operations.

Then within cash Flows from Investing Activities, we will start by adding all the sales concerning the plant, machinery, and equipment as they have increased our asset balance and subtract all the purchases that we have made of these long-term capital assets. This will help us in calculating cash flows originating from investing activities.

Then we will move on to the final part of the cash flow statement, i.e., cash Flows from Financing Activities. Here we will add all the items that have infused cash in our capital structure, like the sale of debenture or sale of equity, and subtract all the items that have brought down our cash balance from this aspect, like a redemption of bonds, etc.

The sum of all these 3 line items will give us the cash balance increase/decrease during the year. We will add it to the beginning cash balance to get the ending figure of cash and cash equivalents.

Each of the types of financial statements tracks the inflow and outflow of resources to and from the business firms. As already discussed, these statements let the management learn about the assets it has against its liabilities and obligations, revenue generated against cost incurred, and cash inflow against the cash outflows.

If the number of assets exceeds the number of liabilities to handle, the revenue figures are more than the expenditure made, and the cash inflows are higher than the cash flowing out of the business, the organizations indicate progressive growth. On the other hand, if the scenario is the opposite, the companies indicate moving on an inappropriate track, hence reflecting room for improvement in strategies.

Apart from how these help the management of the firms to take appropriate decisions, they also let investors assess and analyze the figures indicated in these written records, and compare the same with the figures of other companies. As a result, they better know where to invest in.

The financial statements, if studied individually, might not yield reliable results so far as helping in decision-making is considered. While one statement might indicate the good performance of a company, another might show a different result. Thus, studying different types of financial statements and analyzing each of them to come to a reliable and proper conclusion is a must.

This has been a Guide to what are the Types of Financial Statements. Here, we explain the concept with examples, purpose, importance, and limitations. You may learn more about Accounting from the following articles –

• Users of Financial Statements
• What is the Financial Statement Audit?
• Interim Financial Statements
• Pro Forma Financial Statements