SMALL BUSINESS RESOURCES
What is a financial statement?
4 min read
What is a financial statement and why is it important? Understanding the ins-and-outs of creating a financial statement will buttress your business against financial uncertainty. It also provides a framework for providing a formal declaration of your financial position.
A financial statement will provide internal clarity over your business’s financial condition. Or it can be a key piece of evidence when you’re courting investors or consulting with business advisors. It can also be a crucial part of your accounting activities.
We’ll take you through the four primary types of financial statements and the basics of what is financial reporting for any UK business.
What is financial reporting?
A financial statement is a formal and professionally organised set of documentation designed to report your business’s financial position and performance.
What does the statement of your financial position show? If you were to seek financing from a banking institution, approach advisory services for a consultation, deal with government agencies, or sell your business, a financial statement would be a necessary piece of evidence in your toolbox.
What are the 4 types of financial statements?
A common financial statement will include four primary sections which work in tandem to provide the overall or master financial statement. The four components of a financial statement are:
- balance sheet
- cash flow
Let’s unpack the details you should include and the purpose behind the four types of financial statements.
Type 1 – Balance sheet
The first component of your financial statement is your balance sheet.
The balance sheet is itself divided into four sections that outline the following during any given time period:
- current liabilities
- current assets
- shareholder equity
A balance sheet follows a particular formula:
Liability + shareholder equity = assets
Let’s investigate the three aspects of your balance sheet in more detail.
Assets refer to the physical and intellectual properties that are owned by a business. Assets are generally defined as things which hold value and can be either sold directly for financial gain or can be used to create a product that holds its own value.
Assets can be (but are not limited to):
- cash you hold in a bank or on-hand
- real estate property you own or equity therein
- business equipment and vehicles
- your stock or inventory
- any intellectual property you own such as copyrights or trademarks
- accounts receivable
A liability is defined as that which a business owes. Your liabilities will include debt such as a business loan, but also your known outgoing expenses, financial commitments, or ongoing contractual responsibilities.
A business’s liabilities can include, but are not limited to:
- rental payments on property or equipment
- tax responsibilities and debts
- your employee’s wages and super
- council and utility rates
- busines loans or lines of credit
- any dividends you need to pay shareholders
Shareholder equity can also be described as your business’s capital or net worth.
The shareholder equity can literally refer to the equity owned by your shareholders. However, if you’re the sole business owner with no shareholders, this refers to the business owner’s equity in their own business.
To discover shareholder equity, the formula is as follows:
Assets – liabilities = shareholder equity
If you were to sell all your assets and settle all liabilities, the shareholder equity is the resulting value your business holds.
In this way, the shareholder equity is the capital you’d have left if you settled all business concerns.
Type 2 – Income statement
The second segment of your financial statement is your income statement.
An income statement is designed to discover and communicate your business’s profit or net income through an analysis of revenue vs. expenses.
You would normally create an income statement for set periods of time, such as yearly or quarterly. When reporting on your income statement, it’s customary to also include income statements from preceding time periods to ascertain a broader picture of a business’s net income trajectory.
To create an income statement the following formula is applied:
Revenue – expenses = net income
Type 3 – Cash flow statement
Your cash flow statement is a declaration of how your business spends its capital.
A cash flow statement doesn’t follow any exacting formula, as other aspects of a financial statement do. Instead, the cash flow statement is a broader illustration of how your business both generates income and spends cash.
The cash flow section outlines how your business invests in growth, where it creates most of its wealth and where your expenses lie. This statement will indicate a business’s structure, goals, health and can also be used for predictive purposes.
Type 4 – Notes
The notes section is an often-overlooked segment of your financial statement.
This section acts as a more detailed index of your assets and liabilities.
While the summary of these aspects will be included in the above sections, a notes segment allows a more detailed overview and complete listing of your fixed assets or expenses.
By summarising your assets and expenses in the preceding sections and detailing them in your notes, you create a more digestible financial statement with pertinent details left for those who’d like to drill down into the finer points.
What is financial reporting?
Now that we have a solid understanding of the layout and purpose behind a financial statement, it’s wise to get a picture of financial reporting, which often follows the creation of your financial statement.
What is financial reporting exactly? Financial reporting refers to the process of broadcasting, informing, or disclosing your financial statement to a variety of audiences.
The receiving party may be the wider market, potential buyers, auditors, investors, or management.
Types of financial reporting
When it comes to financial reporting, or the act of disclosing your financial statement (at least in part) there are a variety of avenues depending on your intention.
Firstly, the primary vehicle of reporting is to publish and distribute your financial statement verbatim. This can simply be a PDF or similar document that you share with your intended audience.
However, financial reporting doesn’t always involve the holistic publishing of your entire financial statement. It could also involve any manner of communication that informs the recipient of a certain aspect of your statement.
Such financial reporting can involve:
- disclosures you make on your website or blog
- sending out a press release
- reports to stockholders
- meetings and discussions
- information you give to advisors
If your intention is to run a financially successful and well-articulated business in the UK, creating a sound financial statement is a key activity you should be undertaking.