What is a financial statement?

4 min read

A financial statement is a structured document which is created to record and display the financial performance of a business. 

Often scrutinised by accountants, tax professionals, shareholders, prospective buyers and government agencies, a financial statement is used to ensure the accuracy of a business’s purported financial position for compliance and investment purposes. 

If you were to sell your business or seek investment, a financial statement is crucial. It’s also useful internally as a gauge of business performance when investigating profitability and debt.

Most financial statements include:

  • a balance sheet
  • an income statement
  • a cash flow statement.

Types of financial statements 

There exist three main types of financial statements which you should familiarise yourself with. These three types of financial statements are usually separate components of a master financial statement.

Type 1 

Type one is your balance sheet.

A balance sheet is a type of financial statement which records an overview of your liabilities, assets and shareholder equity at any particular point in time.

The basic formula for a balance sheet is as follows: assets = (liability + shareholder’s equity).

It should be noted that ‘shareholder’ in this instance can also simply be the business owner or business owners themselves, if no other shareholders have stock in the business.

Let’s look at the three primary components of a balance sheet:

1) Assets

Assets are essentially the things that a business owns which have value. Assets are generally items which can either be sold for profit or can be used to create products or services which have market value. Examples of assets include:

  • cash
  • property
  • equipment
  • vehicles
  • inventory
  • trademarks or intellectual property

2) Liabilities

Liabilities are the debts that a business incurs or holds. Liabilities include any outgoing expense, obligation or debt such as:

  • rent
  • taxes
  • payroll
  • rates
  • bank loans
  • dividends

1) Shareholder equity

Shareholder equity is often defined as capital or net worth. 

The shareholder equity is the value that remains in a business after they’ve settled all liabilities and sold all assets. 

This remaining value is what the owner of a business, or shareholders in a business, would be left with in the form of capital.

Type 2 

Type two is your income statement.

An income statement is used to deduce and convey the net income of a business over a defined period. 

An income statement is usually produced yearly, half yearly or quarterly. It’s often accompanied by previous year’s income statements for the sake of comparison.

The point of an income statement is to provide an overview of revenue, expenses and, ultimately, net income.

The basic formula of an income statement is as follows: net Income = (revenue − expenses).

When producing an income statement, the following steps should be taken:

  1. Add up all sales or revenue for the period.
  2. Add up all business expenses and costs for the period.
  3. Subtract total expenses from revenue to reveal net income or profit for the period.

Type 3

Type three is your cashflow statement.

A cashflow statement is a complimentary statement to the above and doesn’t follow a specific formula. Instead, a cashflow statement sheds light on how a business generates and uses cash. 

Understanding where a business’s cash is coming from and how it’s being used generates a picture of the business’s health, structure and financial footing.

Many cashflow statements include detail around:

  • operating activities
  • investment activities
  • financing activities

What is financial reporting? 

So, what is financial reporting exactly? 

Financial reporting is simply the process of disclosing financial activity and statements to relevant third parties. 

Financial reporting covers the communication of financial statements and related information to investors, management, auditors, potential buyers, the general public and financial advisors.

Types of financial reporting

There are many types of financial reporting which aren’t limited to the creation of a financial statement. Obviously, the distribution or publishing of a financial statement is a primary mode of financial reporting, but it also covers other activity such as:

  • press releases
  • conference calls and meetings
  • website copy
  • reports to stockholders
  • reports to compliance entities
  • prospectuses

Free financial guide

Get a handle on the various terms and processes involved with the financial management of your small business with our in-depth guide.