The four basic financial statements
/What are the Four Basic Financial Statements?
A complete set of financial statements is used to give readers an overview of the financial results and condition of a business. The financial statements are comprised of four basic reports, which are noted below.
Income Statement
The income statement presents the revenues, expenses, and profits/losses generated during the reporting period. This is usually considered the most important of the financial statements, since it presents the operating results of an entity. A sample income statement appears next.
Among the most common line items found on an income statement are the following:
Revenue (or sales). Revenue is the total income generated by a company from its core operations—typically from selling goods or services. It is usually shown net of discounts, returns, and allowances.
Cost of goods sold. The cost of goods sold represents the direct costs attributable to the production of the goods or services sold by a company. It includes direct labor, raw materials, and overhead costs directly tied to production.
Gross profit. Gross profit is calculated by subtracting the cost of goods sold from the total revenue. It shows the profitability of a company's core business operations before accounting for operating expenses.
Operating expenses. Operating expenses represent the costs required to run the company's day-to-day operations. They typically fall into several categories:
Selling expenses (marketing, sales salaries, commissions)
General and administrative expenses (office salaries, administrative expenses, rent, utilities, insurance)
Research and development (expenses incurred in developing new products or improving existing ones)
Operating income. Operating income reflects the profit from a company's primary business operations after deducting operating expenses from gross profit. It excludes non-operating income and expenses.
Non-operating income and expenses. Non-operating items are gains, losses, income, and expenses unrelated to the company's core operations, such as interest income, interest expense, investment gains and losses, and gains or losses from the sale of assets.
Income before income taxes. This line represents earnings before deducting income tax expense. It includes operating income plus or minus non-operating income and expenses.
Income tax expense. Income tax expense represents the estimated taxes due based on taxable income. This figure includes current and deferred tax amounts recognized during the period.
Net income. Net income is the bottom-line result, representing the total profit or loss after deducting all expenses, including taxes, from revenues. It indicates the overall financial performance and profitability of a company for a specific period.
Balance Sheet
The balance sheet presents the assets, liabilities, and equity of the entity as of the reporting date. Thus, the information presented is as of a specific point in time. The report format is structured so that the total of all assets equals the total of all liabilities and equity (known as the accounting equation). This is typically considered the second most important financial statement, since it provides information about the liquidity and capitalization of an organization. A sample balance sheet appears next.
Statement of Cash Flows
The statement of cash flows presents the cash inflows and outflows that occurred during the reporting period. This can provide a useful comparison to the income statement, especially when the amount of profit or loss reported does not reflect the cash flows experienced by the business. This statement may be presented when issuing financial statements to outside parties. A sample statement of cash flows appears next.
Statement of Retained Earnings
The statement of retained earnings presents changes in equity during the reporting period. The report format varies, but can include the sale or repurchase of shares, dividend payments, and changes caused by reported profits or losses. This is the least used of the financial statements, and is commonly only included in the audited financial statement package.
When the financial statements are issued internally, the management team usually only sees the income statement and balance sheet, since these documents are relatively easy to prepare.
Financial Statement Disclosures
The four basic financial statements may be accompanied by extensive disclosures that provide additional information about certain topics, as defined by the relevant accounting framework (such as generally accepted accounting principles).
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