Joshua V. Azran, partner/owner of Azran Financial (www.azranfinancial.com) talks about the different types of financial statements.
- Balance sheet- summary of assets, liabilities & owners' equities at the end of a specific period
- Income statement- summary of revenues & expenses during a specific period
- Cash flow statement- illustrates operating, investing & financing activities that affect cash during a specific period
When starting a business or when looking as an investor, we’re going to encounter the different types of financial statements and it’s important to understand how these statements interrelate.
The three basic types of financial statements that we’re going to cover are going to be the balance sheet, the income statement, and the statement of cash flows. And we’ll both look at these statements individually and also look at how these statements interrelate to form the entire financial picture.
So let’s start off with the balance sheet, the balance sheet is a snapshot in time. We could think of the balance sheet as bookends, it’s an immediate snapshot and in this case let’s say at 11:59:59 at that moment in time the balance sheet is going to represent the summary of the dollar amount of assets, liabilities and, owner’s equity accounts at the end of a specific accounting period.
Now remember because things may change two minutes later, that might be a deposit, three minutes earlier there might not have been a liability recognize that snapshot balance sheet is only going to recognize that exacts snapshot in time. And again we’re going to look at the balance sheet not only as a snapshot in time but also as bookends.
The balance sheet is going to represent the beginning of a period, the prior of your balance sheet of course is where we referring to it and that’s also going to represent the end of a period. And will take a step back and understand why this is important in a moment. The balance sheet also importantly can also be called the statement of financial position and these terms are generally used interchangeably.
The next major statement we’ll look at is the income statement. In the income statement is the statement of revenues and expenses during a specific accounting period. The income statement versus the balance sheet is going to represent the activity over that period of time, the sum of all activity that took place from that beginning balance sheet period to the ending balance sheet period.
Now, in theory we would think about being able to tie back, we have these bookends and we have most of the activity that took place between this period on the income statement but that only gives us two or three legs of the triangle. The other important piece that we have to understand is how the cash and non-cash items affected these changes on the balance sheet and understanding how these changes along with the income statement affect the balance sheet will help us tie between the two balance sheet periods.
The way we do this is by looking at the statement of cash flows. So the statement of cash flows is going to illustrate the operating, investing, and financing activities that will affect cash during a specific accounting period. And along with the income statement, the statement of cash flows will help us to tie back and forth between two balance sheet periods.
Again, we’ll go back to our book and example and we’ll look at those balance sheets as the two bookends and we’ll look at the income statements as the statement of cash flows as the ways to get in between those two bookends.
One other things that we’re going to look at on the balance sheet is the assets and liabilities and generally on the balance sheet these are going to be listed in order of liquidity. Those assets which are most easily convertible to cash are going to be represented on the top half of the balance sheet and those assets which won’t be as quickly converted to cash represented lower down.
On the liability side, those liabilities which are due more immediately, those which are more current are going to be represented above those liabilities and obligations which may not be due for more time and that’s going to be the split of the period of the balance sheet.
On the income statement, we’re generally going to start off on the top with either revenues or sales and we’re going to work through things like our cost of goods sold to arrive at our gross profit margin. After arriving at our gross profit margin, we’re going to subtract our operating expenses to finally arrive at our net income.
With our statement of cash flows there’s a few different methods but essentially what it’s going to do is it’s going to give you a definition of where your starting cash was, what affected that cash balance and then how we ended up at our ending cash on the ending balance sheet.
As we could see again these three all form the three legs of a triangle and are very important to have these types of comprehensive statements is necessary to make accurate and reliable financial decisions and having an understanding of how these statements represent the financial positions and how the statements represent the activity of a company or entity is very important to understand the financial position of the company and the performance of that company over time.