Chapter 4: Financial Statements

1. Balance Sheet

What It Represents

• The Balance Sheet provides a snapshot of a company’s financial position at a specific point in time.
• It details the Assets (what the business owns), Liabilities (what it owes), and Equity (the owners’ share of the business).

Format

1. Assets
   • Current Assets (Cash, Accounts Receivable, Inventory)
   • Non-Current Assets (Property, Equipment, Long-Term Investments)
2. Liabilities
   • Current Liabilities (Accounts Payable, Short-Term Loans)
   • Long-Term Liabilities (Mortgages, Long-Term Loans)
3. Equity
   • Owner’s Capital / Share Capital
   • Retained Earnings / Reserves

Key Equation

Assets = Liabilities + Equity

Why It Matters

• Shows the net worth of the business (Equity) and how assets are financed (through Liabilities or owner’s investment).
• Investors and lenders often check the balance sheet to evaluate a company’s financial stability and liquidity.

2. Income Statement (Profit & Loss)

What It Represents

• The Income Statement (or Profit & Loss Statement) summarizes revenues, expenses, and resulting profit or loss over a given period (e.g., monthly, quarterly, annually).

Format

1. Revenue (Income)
   • Sales, service revenue, interest income, etc.
2. Expenses
   • Cost of Goods Sold (if applicable), operating expenses, payroll, rent, utilities, etc.
3. Net Profit or Loss
   • Calculated by subtracting all expenses from total revenue.

Key Formula

Net Income = Total Revenue – Total Expenses

Why It Matters

• Reveals how profitable a company is in its core operations.
• Stakeholders use it to assess a business’s performance and potential for growth.
• Guides decisions on cost-cutting, pricing, and investing in new products or services.

3. Cash Flow Statement

What It Represents

• The Cash Flow Statement tracks the inflow and outflow of cash during a specific period.
• It highlights where money comes from and where it goes, categorized into three main activities.

Sections of Cash Flow

1. Operating Activities
   • Cash generated or used by day-to-day business (e.g., cash received from customers, cash paid to suppliers).
2. Investing Activities
   • Cash spent on or earned from investments (e.g., buying equipment, selling assets, or earning investment income).
3. Financing Activities
   • Cash received or paid related to debt or equity (e.g., loan proceeds, loan repayments, issuing shares, paying dividends).

Why It Matters

• Helps business owners see if the company is generating enough cash to sustain operations, invest in growth, or repay debts.
• An indicator of a company’s liquidity and solvency—whether it can meet short-term and long-term obligations.

Key Takeaway

• The Balance Sheet captures a snapshot of financial position (Assets, Liabilities, and Equity).
• The Income Statement shows profitability over a period (Revenues minus Expenses).
• The Cash Flow Statement reveals actual cash movements, detailing how the business obtains and spends its cash.

Understanding these statements is crucial for making informed decisions, securing investments or loans, and ensuring the company’s financial health.