Financial statements are formal records of the financial activities and position of a business, person, or other entity. They provide an overview of a company's financial condition and performance, which is crucial for investors, creditors, and regulators to assess the viability and profitability of the business. Here are the key components of financial statements:
The income statement, also known as the profit and loss statement, shows the company's revenues, expenses, and net income (or loss) over a specific period. It illustrates how the revenues are transformed into the net income or net profit. The fundamental equation for the income statement is:
Revenue - Expenses = Net Income
The balance sheet provides a snapshot of a company's financial position at a specific point in time. It lists the company's assets, liabilities, and shareholders' equity. The balance sheet adheres to the following equation:
Assets = Liabilities + Shareholders' Equity
This statement records how changes in balance sheet accounts and income affect cash and cash equivalents, breaking the analysis down to operating, investing, and financing activities. It answers the question of where the company's cash came from and where it went.
Also known as the statement of retained earnings or equity statement, this document shows changes in equity over time, including retained earnings, dividends, and any changes from capital transactions.
The concept of financial reporting can be traced back to the medieval period when merchants and traders needed to account for their business transactions. However, modern financial statements as we know them began to take shape in the late 19th and early 20th centuries with the advent of corporations and the need for transparency in business operations: