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Fledgling business owners must quickly learn about compliance and tax, but will find themselves asking an important question: what is a financial statement?
Familiarising yourself with all the types of financial statements is essential to New Zealand businesses and their success.
So, what are they? Simply, a financial statement is a formal document designed to convey the financial activity of a business to determine its health.
A financial statement is often viewed and dissected by:
- financial advisors
- tax experts
- prospective business purchasers
- NZ government agencies
The purpose of creating a financial statement is usually to ensure the accuracy of a business’s purported financial performance for either compliance or investment determinations.
If you were to try and sell your business or pursue outside investment, your financial statement would become a critical consideration in these discussions.
A financial statement is also a beneficial document to help understand the performance of a business – its profitability or liability. In this way, a financial statement becomes an internal document of your business’s viability.
The primary components of a financial statements are:
- a balance sheet
- an income statement
- a cash flow statement
Three types of financial statements
There are three primary and different types of financial statements you’ll need to understand and they’re often distinct parts or chapters of a master financial statement.
The first type of financial statement is your balance sheet.
The balance sheet is a kind of financial statement designed to provide an overview of your business’s liabilities, assets and shareholder equity during a specific period of time.
The essential equation of a balance sheet is: assets = (liability + shareholder’s equity).
A ‘shareholder’ in this instance doesn’t always mean an outside investor; it can also mean the business owner (or owners) themselves along with any outside shareholders who own stock in the business.
Let’s investigate the three main pats of a balance sheet:
Your assets are defined as possessions that your business owns which hold value. Assets are usually objects which can be traded for profit or be utilised to make products or services, which will then hold a marketable value. Business assets could include:
- trademarks or intellectual property
Liabilities are defined as the debts that your business is liable for. Liabilities include any outgoing expense, obligation or debt including your:
- bank loans
1) Shareholder equity
Your ‘shareholder equity’ can also be described as your ‘capital’ or ‘net worth’. As before, the ‘shareholder’ could simply be the business owner.
Shareholder equity is defined as the value that would remain in your business after you have settled all your liabilities and traded all your assets.
The remaining value in your business after settlement and sale of assets is the shareholder equity, which can also be defined as capital.
The second type of financial statement we need to consider is your income statement.
An income statement is designed to determine and communicate the net income of your business over a specific period of time.
An income statement can be created for yearly, half yearly or quarterly time periods. It’s often accompanied by previous years’ 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:
- Tally all sales or revenue.
- Tally all business expenses and costs.
- Subtract total expenses from revenue to disclose net income or profit.
The third type of financial statement will be your cashflow statement.
A cashflow statement is a complimentary statement created on top of your balance sheet and income statement. Unlike type one and two however, a cashflow statement doesn’t actually have a defined formula. Alternatively, a cashflow statement is created to illuminate how exactly your business both generates and spends its cash.
Understanding where a business’s income is sourced and exactly how it’s being used, paints a picture of your business’s health, structure, and financial stability.
Most cashflow statements will comprise of information such as:
- operating activities
- investment activities
- financing activities
What is financial reporting?
Financial reporting is basically a method of disclosing financial activity and statements to appropriate parties.
Financial reporting is the activity of communicating your financial statements and assorted relevant business information to parties such as:
- prospective buyers
- general public
- financial advisors
Forms of financial reporting
Financial reporting isn’t necessarily restricted to the creation and distribution of a financial statement in and of itself. Any communication of the components, or distillation of a financial statement is also termed ‘financial reporting’. Other types of financial reporting include:
- press releases
- conference calls and meetings
- website copy
- reports to stockholders
- reports to compliance entities