Introduction to Financial Statements
Understanding financial statements is essential for any investor or person interested in the field of finance. Financial statements provide a clear and structured view of a company’s financial health, facilitating informed decision-making. In this introduction, we will explore the three main financial statements: the income statement, the balance sheet, and the cash flow statement.
*All publicly traded companies are required to report their financial statements to the relevant regulator within the stipulated deadlines and terms. Additionally, these statements must be audited by an accredited external entity.
*Financial statements can be accessed on data aggregator platforms such as TIKR or in quarterly or annual reports available in the “Investor Relations” section of the respective corporate websites.
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1. Profit and Loss - Income Statement - P&L
📌Purpose
The income statement, also known as the profit and loss statement, reflects a company’s profitability over a specific period. Its main function is to show how revenues are converted into profits or losses, providing details about revenue sources, costs, and expenses.
📌Timeframe
This financial statement covers a defined period, such as a month, quarter, or fiscal year. It is a dynamic representation of the company’s financial activity during the analyzed time frame.
📌Comparable to a Personal Financial Situation
The income statement can be compared to a personal budget that tracks income (e.g., salaries or side income) and expenses (e.g., rent, utilities, and entertainment). This budget determines whether a surplus or deficit was achieved in a specific period.
📌Relationship to Other Financial Statements
The net income calculated in the income statement is transferred to the balance sheet as part of retained earnings. Additionally, income and expense items directly affect cash flows in the cash flow statement.
2. The Balance Sheet
📌Purpose
The balance sheet provides a "snapshot" of a company’s financial position "at a specific moment in time." It presents assets, liabilities, and equity, offering a clear view of how the company’s resources are financed.
📌Timeframe
Unlike the income statement, the balance sheet represents a specific point in time, such as the last day of the month or fiscal year. It is a static report.
📌Comparable to a Personal Financial Situation
The balance sheet can be likened to a personal spreadsheet detailing assets (e.g., cash, properties, and savings), liabilities (e.g., mortgages and debts), and net worth (the difference between assets and liabilities).
📌Relationship to Other Financial Statements
The balance sheet reflects the cumulative effects of the income statement and the cash flow statement. Changes in assets and liabilities capture the operational and investment transactions that impact cash flow.
3. The Cash Flow Statement
📌Purpose
The cash flow statement shows how a company generates and uses cash over a specific period. Its objective is to detail the sources and uses of cash in operating, investing, and financing activities.
📌Timeframe
This financial statement also covers a defined period, usually aligned with the timeframe of the income statement.
📌Comparable to a Personal Financial Situation
It can be compared to a record of transactions in a personal bank account, detailing every deposit (income) and withdrawal (expense) and showing the cash balance available at the end of a period.
📌Relationship to Other Financial Statements
The cash flow statement begins with the net income from the income statement, adjusting for non-cash items. Changes in balance sheet items, such as accounts receivable or inventory, also impact cash flows.
4. Interrelationship Between Financial Statements
The three financial statements are interconnected, forming a coherent network that allows analysis of a company’s financial health from different angles:
· Integration of Net Income: The net income from the income statement is transferred to the balance sheet as part of retained earnings and serves as the starting point for the cash flow statement.
· Impact on the Balance Sheet: Operating, investing, and financing activities detailed in the cash flow statement affect balance sheet accounts, such as cash, debts, and assets.
· Comprehensive View: Together, these statements allow for an evaluation of profitability (income statement), financial stability (balance sheet), and liquidity (cash flow statement).
Source: @BrianFeroldi (X), https://brianferoldi.kit.com/99