The information found on the financial statements of an organization is the foundation of corporate accounting. This data is reviewed by investors and lenders for the purpose of assessing the company’s level of financial stability. Data found in the balance sheet, the income statement and the cash flow statement is used to calculate important financial ratios that provide insight into how the company’s finances are being managed and potential issues that may need to be addressed. Investors are able to make well-informed investment decisions based on what a company provides in its financial statements each period. The balance sheet, income statement and cash flow statement provide different information on a company’s financial position, but these accounting staples are all interconnected.
The Balance Sheet
Also referred to as the statement of financial position, a company’s balance sheet provides information on what the company is worth. The balance sheet reports the totals of a company’s assets, liabilities and shareholders’ equity on a specific date, and it mimics the accounting equation expressed as assets = liabilities + shareholders’ equity. An asset of a company can only be obtained through shareholders’ equity or by taking on a liability, such as a bank loan or line of credit, so the balance sheet reflects the direct relationship between these transactions. Instead of showing individual accounting transactions, the balance sheet acts as a snapshot of the company’s accounts at the end of an accounting period. An increase or decrease in assets due to profit or loss is transferred to the balance sheet directly from a company’s income statement.
The Income Statement
A company’s income statement reports the level of revenue a company earned over a specific time frame as well as the expenses directly related to earning that revenue. Companies first list gross revenue from product or service sales, and then subtract any money not expected to be collected on specific sales due to returns or sales discounts. This results in the company’s net revenue. All expenses related to the cost of sales are subtracted from net revenue to reach gross profit. All operating expenses are then deducted from that total, resulting in operating profit before interest and income tax expenses. Net earnings or losses are listed as the bottom line of the income statement after expenses for interest and taxes are deducted. Any increase or decrease in assets due to profit or loss reported on the income statement is transferred to the balance sheet, and total profit or loss reported on the income statement is included in the statement of cash flow under cash flows from operations.
The Cash Flow Statement
The cash flow statement reports any cash inflow or outflow over the course of the accounting period. This financial statement highlights the net increase and decrease in total cash on hand for the accounting period. The cash flow statement is broken down into different sections, including operating, investment and financing activities. The information in the cash flow statement explains changes shown in the numbers reported on the balance sheet, and it explains transaction level changes in net profit or loss as reported on the income statement.