The components of financial statements

THE COMPONENTS OF FINANCIAL STATEMENTS

In the last article we said that financial statemenst are prepared on monthly / quarterly /half yearly and annual basis. Now, irrespective of the time period, financial statements ( or ‘financials’ as it is called in common parlance) basically consists of three parts:

  • Income statement or Profit and Loss account
  • Balance Sheet
  • Cash flow statement

Most of the figures shown in the annual financial statements will be in a summarized form since – for example the total of all the assets like machinery, buildings, plant, tools, vehicles, computers etc will be shown in the balance sheet as ‘fixed assets’. If you want to know about the details of fixed assets, you may have to refer to the schedule of fixed assets attached with the balance sheet. A big company may have many more schedules like the one mentioned above.

Apart from schedules, accounting rules allow accountants to calculate certain figures based on certain assumptions – for example the company may have given a lot of goods on credit and based on past experiences, the accountant may write off certain percentage of debtors (amounts receivable from credit sales) as irrecoverable. Such assumptions made while preparing financial statements will be separately disclosed in a statement called ‘notes to accounts’.

Apart from this, the independent auditor may also have his opinion about the correctness of the assumptions made and about the truth and fairness of the figures disclosed in the financial statements. He discloses his opinion and comments in a report called the audit report.

So apart from the 3 components that comprise financial statements, the following three statements also form part of it as a sub category-they are-

  • Schedules to accounts ( Part of balance sheet and income statements)
  • Notes to accounts. ( Accountant’s disclosure about the assumptions made)
  • Audit report (Independent auditor’s comments and opinion)

So there are three components and three sub-components for any financial statement. Now we will explain in brief what those 3 statements are about.

INCOME STATEMENT

The income statement summarizes a company’s sales (Also called revenues or turnover) and expenses. The final net figure is either profit (if total of revenues exceed Expenses) or loss ( if expenses exceed revenues).The ‘profit’ or ‘loss’ shown in this statement is essentially an ‘estimate’( we will tell you why, later ! )  For example – if a company reports of having made a profit of Rs 300 Crore, it doesn’t mean that it has Rs 300 Crore in it’s bank account.

BALANCE SHEET

A balance sheet summarizes a company’s assets, liabilities and shareholders’ equity at a specific point in time. These three balance sheet segments give investors an idea as to what the company owns and owes, as well as the amount invested by the shareholders.

CASH FLOW STATEMENT

‘Profit’ and ‘cash’ are not the same. A statement that shows ‘actual cash’ coming in and how the same has been used is called the cash flow statement. It deals with liquidity. Being profitable does not necessarily mean being liquid. A company can fail because of a shortage of cash, even while profitable. So to analyse the economic realities, cash flow statements are prepared.

CONCLUSION

Financial statements provide financial statistics of past events; but they are not forward looking. They don’t provide key non-financial information like quality of revenues, types of customers and risk factors. Certain qualitative elements are not considered in the financial statements terms like the quality and reputation of the management team and employees because they are incapable of being measured in monetary terms. The figures provided in financial statements can’t be attributed to future since future earnings depend on many more factors like local and global market conditions, inflation etc. Limitations apart, these are the numbers which an investor depends. The assumption is that ,a company which has given excellent numbers in the past is capable of delivering improved results in the future also.

IN THE NEXT ARTICLES.

We dig deep into each of these statements and try to understand what it’s all about. Understanding the three statements are absolutely necessary to analyse a company fundamentally …

You may like these posts:

  1. Introduction to financial statements
  2. How to read an Annual report.
  3. Understanding Annual reports.

1 Response to “The components of financial statements”

Sadath

November 24, 2012 at 11:29 am

Dear Victor,

Thank you for the very informative articles.

Could you please consider posting an article on Break Even analysis.

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