4 Types of Financial Statements and How They Work
In the world of accounting, financial statements are documents that contain all the information you need to see how a company is doing financially. There are several different types of financial statements, each of which are used by the company's managers, market analysts, creditors, and even investors to get an overall picture of a company's financial health. Join us for a crash course in the four major types of financial statements and how they work.
What are Financial Statements?
Financial statements are basically formal, written records of the financial activities of a business or even an individual person. By analyzing the information these statements contain, it's possible to see how the company is doing now and make reasonable predictions about how it will do in the future.
A company's financial statements make up an important part of its annual report, which can give investors important clues as to which way the company's stock prices will swing. Let's take a look at the four types of financial statements and what kind of information they contain.
1. Balance Sheets
A company's balance sheet, aka "statement of financial position" provides a look at the company's assets, liabilities, and shareholder's equity. By taking these three considerations into account, analysts can figure out what's known as the company's "book value."
A company's assets include things like cash, cash equivalents, money the company is own, and its inventory.
Liabilities, on the other hand, are basically a calculation of their debt. This can include things like long-term debt, wages that are owed, or dividends owned to shareholders.
- Shareholder's Equity
Shareholder's equity is the amount of money the company would owe shareholders if they all liquidated their shares at once.
Ideally, a company's assets will at least equal, if not outweigh, its liabilities and equity.
2. Income Statements
Income statements are used to calculate a company's net income. They do this by factoring in not only how much a company has earned, but also how much money they have had to spend. These are grouped into sections such as:
- Direct expenses
Direct expenses are generally related to things like the "cost of goods sold," which is how much it costs a company to produce the products they sell.
- Indirect expenses
Indirect expenses are associated with the cost of running a business itself. Expenses in this category will include things like salaries, research, administration expenses, etc.
- Capital expenses
Capital expenses factor in the costs of maintaining or improving things like machinery, vehicles, or other equipment needed to keep the business running.
In addition to specifying the company's expenses and how they are allocated, income statements also look at how much money the company has earned. It will factor in both operating revenues, which is how much the company earned from the sale of its goods or services and non-operating revenue, which is money earned through things like interest, the sale of old machinery, etc.
3. Cash Flow Statements
Cash flow statements are designed to give an idea of how a company uses its cash. A cash flow statement is divided into three different sections, each of which concerns one of the different ways the company's cash is being spent.
- Operating Activities
Cash that's spent on operating activities can include anything from cash spent on rent to taxes to wages. This section shows the amount of cash the company spends on keeping the business up and running.
- Investing Activities
This section is concerned with cash that's been spent on things that are considered an investment in the company's future. This can include anything from actual investments to loans, new equipment purchases, or property.
- Financing Activities
Cash spent on financing cover things like cash or dividends paid to shareholders, loans, or the repayments of debts of any sort.
4. Statements of Shareholder's Equity
Statements of shareholder's equity are technically part of the company's balance sheet. As an investor, this can be an important statement to focus on, however, as it provides an overview of the value of a company's stock over time.
The shareholder's equity statement contains a number of components that help explain why the value of their shares either rose or fell. It can also be an important clue as to whether the stock is worth holding onto in the future or whether it's time to think about selling.
How to Read Financial Statements
As you may have already gathered, learning to read a financial statement is a skill that largely boils down to understanding an array of different financial terms. When it comes each of the three main types of financial statements down to the information you're looking for, here are the most important pieces.
- Balance Sheets
Assets = Liabilities + Owners’ Equity
- Income Statements
Net Income= Revenue− Expenses
- Cash Flow Statements
The cash flow statements is less about profits and more about getting a picture of how the company spends their money in the areas of operations, investing, and financing.
Why are Financial Statements Important?
Learning to read financial statements allows you to gain a very clear picture of any company's financial health. As an investor, this can be a powerful way to identify opportunities or spot problems before they affect your investments. By learning to minimize risk, you can make better and smarter trading decisions.
While accountants and manager are trained to read and understand financial statements, few investors who work in other industries are. This can give you a real edge in the market by being able to identify which companies are worth investing in and when.
How to get a Financial Statement
In the United States, publicly traded companies are required to file a large number of reports with the SEC. The SEC then makes these reports available to the public through their Electronic Data Gathering, Analysis, and Retrieval system (EDGAR). Simply visit the EDGAR database and search the company you're interested in by it's name or ticker symbol.
You'll be able to access the companies latest report and should find all the information above in their annual report. Company's tend to be pretty transparent about this information and a great deal of it can also be found on the company's profile page on the average brokerage trading platform.