Running a stable and successful business requires understanding, creating, and sharing accurate financial statements with partners, organizations, and relevant authorities that govern and work in your industry.
To be considered for an open government bid project, for example, a company must have specific business documents and financial statements to show its capacity and experience in completing similar projects.
Financial statements reveal if a business has the ability to take on and pay back loans at agreed terms or is eligible for financial support in specific situations.
Simple agreements may be enough for small projects and businesses, but providing supporting financial statements is crucial to back up business assertions and kick-start transaction processes when seeking funding, buying capital assets, or being involved in high-stakes business activities.
This article aims to answer all your frequently asked questions about financial statements. We’ll define what they are, share why they are essential, and introduce three primary financial statements you need to keep your business going. We'll also share examples of each, how they work together, and how to set up a seamless financial accounting system for your organization.
What are financial statements?
Financial statements are curated records of an organization’s activities and financial performance for a specific period, e.g., monthly, quarterly, or yearly. They present an accurate, realistic summary of a business’s work.
Financial statements provide proof of worth, operations, and compliance with tax laws and other regulations. They document and communicate a company’s financial position and growth over time. As well as complying with regulations, creating regular financial reports makes it likely for business leaders and managers to discover unique opportunities, proactively mitigate risk, and efficiently prioritize projects to achieve big goals.
Each financial statement on its own tells something about the business. The balance sheet, for example, provides a snapshot of what the business owns and owes at a specific time. The statement of changes in shareholder equity documents total equity and changes over time. Altogether, the three primary financial statements (listed below) reveal a more complete picture, including the business’s capital, assets and liabilities, expenses and revenues, and cash flows from various activities.
Why are financial statements important?
Financial reports reveal distinct insights into how an organization receives and manages its money. These statements show how money enters a business, what it is spent on, and what it yields.
Different types of financial statements are uniquely beneficial for the performance of the business. A few benefits of financial statements include:
- Compliance: Financial statements help maintain compliance with different international, federal, and state laws
- Transparency: Financial statements reveal the business activities and investments bringing in the most return on investment
- Fundraising: Financial statements provide information to banks, investors, and creditors to convince them to invest in the business
- Performance tracking: Financial statements show how a business got where it did. They highlight the costs, equipment, and teams needed to get a business to its current position
- Improved decision-making: Financial statements help executive teams to make better strategic decisions, including where and when to invest, and when to retain profits
- Trend mapping: Financial reports help to identify trends in an industry and ensure that the business progresses in line with its goals
- Debts and liabilities structuring: Financial statements help accounting teams structure debts and liabilities
- Gathering updated data: Financial statements help the executive team make better decisions by getting accurate, updated information
- Maintaining liquidity: Reading financial statements correctly and gathering insights can help forecast curves, mitigate risks, and maintain financial liquidity for the business to operate
- Progress tracking: Financial statements provide a rich history of an organization's progression right from when it was founded to the current time period
Types of financial statements
There are three main financial statements businesses produce:
- Balance sheet
- Income statement
- Cash flow statement
Balance sheets show what an organization owns and what it owes within specific periods, income statements show how much money the organization makes and spends in a period, and cash flow statements show how the organization exchanges money with the outside world during a fixed time.
Let’s take a deeper look at each one with examples.
1. Balance sheet
The balance sheet expresses the financial position of a business. It shows three things about a business’s financial health: its assets, liabilities, and shareholder equity (or capital). When combined, these three elements make up the worth of the business for the period the balance sheet covers.
An organization’s assets must always equal its liabilities and shareholder equity. This is a sign, though not a conclusive one, that the balance sheet is ‘balanced’ and accounts are in alignment.
Assets = Liabilities + Shareholder Equity
Assets
Assets are things a business owns that have value. This includes tangible property, such as factories, vehicles, machinery, and inventory. It also includes intangible things that have value but can’t be seen or touched, such as goodwill, trademarks, and patents.
Assets are grouped based on their ease of convertibility into cash. They are grouped as fixed or current assets (or short-term vs. long-term assets). Cash is a short-term asset. It’s liquid and can be exchanged easily. Property and equipment are long-term assets. They are great examples of fixed assets and cannot be exchanged easily.
For an item to be considered an asset, it must be owned and have economic value. Assets can depreciate or appreciate over time. Accounting professionals use financial techniques such as depreciation and amortization to calculate the worth of assets so they can replace or sell them at the most optimal time.
Liabilities
Liabilities are services, products, and resources a business owes to others. This includes commitments, like money borrowed to mobilize a project, payroll owed to employees, or taxes owed to the government. For an item to be considered a liability, it must be borrowed and have economic value.
There are short-term and long-term business liabilities. Quick loans, unearned revenue (payment received before a business delivers the required goods or services), and sales taxes payable are examples of short-term business liabilities. Bonds and mortgages payable are long-term business liabilities.
Maintaining a good debt-to-asset and debt-to-equity ratio — i.e., calculating your organization’s total debt relative to its total assets and equity — helps maintain financial stability. These ratios tell if you have enough assets to cover your debts and obligations and stay afloat in dire circumstances.
Shareholder equity
Shareholder equity is an ownership claim on a company’s assets after settling debts and obligations. It is the company’s assets minus its liabilities. Shareholder equity represents the amount of money to be returned to shareholders if the company assets are liquidated and debts paid off.
Shareholder equity comprises stock components, contributed capital, and retained earnings (a part of shareholders’ equity that is not paid to shareholders as dividends but instead put back in to boost business growth and activities.)
Shareholder equity can be either positive or negative, depending on the organization’s debt-to-asset and debt-to-equity ratios. Even in organizations where the business assets and equity are typically more than liabilities, there can be rare occasions where things flip and the company debt value exceeds assets, meaning shareholder equity becomes negative.
Example of a balance sheet
2. Income statement
Also called the Profit and Loss (P&L) statement, the income statement helps determine whether the business turned a profit or loss for each period.
An income statement summarizes a business’s profitability and financial results for a period. It focuses on revenue and expenses. This financial report shows what it costs to create your products and services and keep the business running. It is handy to compare how an organization’s revenues increase or decrease over multiple periods.
Each income statement shows:
- Revenue: This is the amount of money a business makes in a period. Revenue is money earned from a company’s business activities, e.g., manufacturing and selling products. This is called business operating revenue. Revenue can also be realized from other activities not directly related to the operating activities. These are non-core business revenue, e.g., interest on money in the bank.
- Expenses: This is the amount of money a company spends to make money. Expenses include material procurement, cost of goods sold, overheads, employee wages, and administrative and petty expenses such as transportation and stationery, etc.
- Costs of goods sold: This is the cost of all that’s needed to make the company’s products or services. Cost of goods sold is a primary business expense and directly affects the company’s profits.
- Gross profit: This is the amount arrived at after subtracting the cost of goods sold from the business’s total revenue (sales).
- Operating income: This is the amount arrived at after deducting operating expenses such as the cost of goods sold, staff salaries, and depreciation. It is, simply put, gross profit minus operating expenses.
- Income before taxes: This is a company’s net income after operating expenses, but not taxes, have been paid. This is calculated by subtracting non-operating income from operating expenses.
- Net income: This is income before taxes minus taxes. It is calculated as revenue (sales) minus the cost of goods sold, operating expenses, general and administrative expenses, depreciation, interest, taxes, and other expenses. It shows how much revenue is left after all expenses are paid.
- Depreciation: Depreciation is an accounting method used to allocate the cost of an asset over its life. It accounts for the extent to which tangible assets lose value over time and allows companies to earn revenue from assets they own by paying for them over time.
- Earnings per share: Earnings per share is calculated using net income. It is calculated by dividing net income by the number of outstanding shares. The higher a company’s earnings per share, the more profitable it is considered to be.
Example of an income statement
3. Cash flow statement
A cash flow statement measures how well cash flows through an organization to keep operations running, pay employees, honor obligations, and invest in opportunities. It is the third primary financial statement businesses must produce.
Cash flow statements enable the management team and stakeholders to understand how a company runs: if there’s sense, process, and predictability in the operations and if the company is on solid financial footing.
Cash flow statements include three main sections:
- Operating activities: Operating activities cover money, assets, and resources used for running operations and carrying out the company’s trade. Cash from operating activities includes employee wages, income tax payments, interest payments, overheads, accounts payable, inventory, and depreciation.
- Investing activities: Investing activities cover a company’s investments in its future. These can include purchases or sales of property or other assets, loans taken to pursue opportunities, and mergers and acquisitions.
- Financing activities: Financing activities cover investments from investors and banks as well as dividends paid to shareholders. Financing activities include debt and equity issuance, stock repurchasing, loans, and repayments.
Example of a cash flow statement
Other financial statement examples required for specific companies and situations include:
- Statement of changes in shareholder equity: A statement of changes in shareholder equity shows equity share changes among shareholders over time. It highlights any changes made to a company’s share capital and accumulated reserves, and records how profits are retained or distributed. This statement tracks total equity over time, tying back to the balance sheet for the same period.
- Statement of comprehensive income: A statement of comprehensive income summarizes revenues and expenses that have been invested in but not yet realized. It accompanies the income statement to show a more complete picture of the business. Examples of transactions reported in a statement of comprehensive income include:
- Unrealized translation adjustments due to foreign currency
- Unrealized gains or losses from debt securities and derivative instruments - Statement of retained earnings: A statement of retained earnings shows how much a business earns and retains in the business in a period. It serves as a measure of the assets and activities retained in the business for more business activity, not paid out to shareholders as dividends.
- Accountant’s report: When an external accountant prepares or reports on an organization’s financial statements, an accountant’s report must be attached along with the financial statements. This report tells you about the accountant’s audits and the status of the books.
How are these financial statements used together?
Anyone can learn how to create and draw insights from a company’s financial reports. Investors, business owners, and project managers need to understand the results and trends to drive the business successfully.
The three primary financial statements are intrinsically linked. The net income balance from the income statement opens the cash flow statement in the operating activities section. The cash balance from the cash flow statement at the end of the period becomes an asset in the balance sheet, indicating its worth to stakeholders and investors.
Use Wrike to improve your financial statements system and organization
When it comes to creating financial reports and making your finance and accounting teams more efficient, it is essential to set up the right processes, secure access, and use trusted sharing software.
Wrike’s project management software for financial services can help you improve your organization’s financial statement creation process and streamline project management for accounting and finance teams. Wrike provides transparency for team members and stakeholders to see how money coming into the business is spent.
With a clear view and accessible insights, executive and management teams can make better strategic decisions, guiding managers to prioritize projects and use resources where the organization can gain the most impact.
Here are three specific ways Wrike helps accounting teams:
- Time tracking: Wrike offers a time tracking feature that enables team members and managers to learn, adjust, and focus resources on more valuable, billable work, and improve project and operations planning.
- Invoicing: You can also use Wrike to track your financial data and sync with billing platforms for efficient invoice management. Wrike helps to assess time and effort to determine the appropriate fees to be charged and exports this data for easy invoice generation.
- Costing and budget management: Wrike’s budget management features allow teams to monetize work provided, log time needed and spent, and allow hourly rates to be assigned at a user, job role, or project level.
Are you ready to improve your financial statements and services management with our software? Get started now with a free two-week trial.
