4 Types of Financial Statements: What They Are and Why They’re Important

What are financial statements?

Financial statements are written documents that outline the business activities of a company. These statements are analyzed to infer the financial performance and well-being of a business, helping make future projections and decisions based on historical trends.

The 4 types of financial statements

You can’t decipher financial well-being from a single financial statement—you need different perspectives to paint a clear picture. There are four primary types of financial statements:

1. Balance sheets
2. Income statements
3. Cash flow statements
4. Statements of shareholders’ equity

But before we dive in, know that all financial statements are inward-looking and historical. They don’t come with built-in insights and suggestions for what to do about the data. Rather, it’s up to you to deliver a future-forward strategy based on your findings. That’s where a function like financial planning and analysis (FP&A) comes into play, helping your business analyze and execute forecasts and trends.

Each statement provides a unique lens and set of data with enriching insights to transform your overall strategy.

1. Balance sheet

The balance sheet is an item-by-item breakdown of everything the company owns, including assets, liabilities, shareholder equity, and other variables during a specific moment in time. Balance sheets also communicate exactly how much a company is worth, totaling the value of these variables into a single monetary total.

The following is a breakdown of a balance sheet’s format:

• Assets: What does the company own? Buildings, inventory, cash—everything is listed as an item on the balance sheet. These can be further broken down into current assets (cash, inventory, accounts receivable) and non-current/fixed assets (property, equipment, patents, licenses)
• Liabilities: What does the company owe? Long-term debts, accrued expenses, deferred revenue—every outstanding expense the company still has to pay is listed in this section. The cost of every liability is also totaled up to reflect a single price point
• Equity: What is owed to the owners of the company? Whatever money is left after liabilities are accounted for goes to the owners of the business. This is broken down into categories similar to those in the statement of shareholders’ equity, such as common stock and preferred stock

A company’s balance sheet and other financial statements can be analyzed from multiple points of view.

Internal balance sheet insights

The internal view encompasses the needs and perspectives of business leaders, employees, shareholders, and other internal players. Invested parties use the balance sheet to get a snapshot view of whether the company is succeeding or failing. Depending on their findings, the internal players may make policy or financial changes to remedy shortcomings or bolster successes.

External balance sheet insights

The external view of a balance sheet is typically for potential investors and regulators who may have specific requirements for what information to share and how to present it. For those interested in purchasing shares, the balance sheet offers insight into what resources are available to the business and how those resources are financed. Based on their findings (along with any additional insights gleaned from the risk report), potential investors will determine if the company is worth investing in.

You cannot gather these insights from a single document. Comparing your current balance sheet to previous periods will reveal potential trends that can be compared and assessed.

2. Income statement

Sometimes referred to as a profit and loss statement, income statements describe what the company did with the money it earned and spent. This essentially reveals its activities between balance sheets. Income statements include all revenues, expenses, gains, and losses that occurred during a period. This is often broken down into the following categories:

• Revenue: How much money a business earns during the recorded period
• Costs of goods sold (COGS): The cost behind what it takes to make the units sold
• Gross profit: Total revenue minus COGS
• Expenses: How much money the company spent during the recorded period
• Operating income: Total profits minus any operating expenses, such as labor
• EBITDA: Earnings before interest, depreciation, taxes, and amortization
• Depreciation: How much value its assets have lost over time
• Income before taxes: Income minus costs but before the exclusion of applicable taxes
• Net income: Total income after all costs are subtracted
• Earnings per share: Income divided by the total number of outstanding shares

Income statements paint a picture of a company’s financial performance. Therefore, potential investors gain further insight into the company’s profitability. Additionally, investors can compare income statements against projected earnings to determine whether or not a company is on the right track.

Want to learn more? Check out our blog,?How to prepare an income statement .

3. Cash flow statement

Cash flow statements show how the company uses its revenue. These give investors and shareholders a direct look into how effectively the company is spending its money, particularly in the context of long-term and short-term investments.

A cash flow statement is broken down into three categories:

• Financing activities: Cash flow from debt or equity financing
• Investing activities: Cash flow from purchasing or selling assets using free cash, which may include real estate investments, vehicles, or the purchase of non-physical assets such as patents and licenses
• Operating activities: Cash flow that encompasses regular goods and services, including both the associated revenue and expenses

Direct vs indirect cash flow

Cash flow statements cover two forms of cash flow methods: direct and indirect. The direct cash flow method is a simplified approach to seeing how cash flows in and out of your business. Cash flow statements using this method will attribute cash movement to actual items, like salaries, vendor payments, or interest payments.

An indirect cash flow method starts with your net income and works backward. Using that net income as a base, a company would add non-cash expenses (like depreciation), non-cash incomes, and any net adjustments between current assets and liabilities. Direct cash flow ignores depreciation and other non-cash factors.

The purpose of cash flow statements

Cash flow statements, like all other financial statements, offer a clear perspective for investors. If the cash flow analysis observes a healthy, consistent cash flow, that is going to inspire more investors than one that is uneven or unsustainable. Internally, a department head might observe irregularities or inefficiencies in the cash flow, which may inspire restructuring or an adjustment of the company’s activities.

4. Statements of shareholders’ equity

The statement of shareholders’ (or stockholders’) equity outlines the changes in ownership interests for the company’s shareholders.

The statement of changes in equity is a relatively straightforward calculation: Simply find the difference between a company’s total assets and total liabilities. However, this financial statement goes deeper than the calculation alone. The statement of shareholders’ equity includes a few key components:

• Common stock: A type of ownership stake in the company that comes with voting rights on corporate decisions—common stockholders have the lowest priority claim on a company’s assets
• Preferred stock: A special ownership stake that offers stockholders a higher claim to a company’s assets and earnings than common stockholders—companies report preferred stocks at face value in the statement of shareholder’s equity
• Retained earnings: The total earnings of a company after it distributes dividends to its shareholders
• Treasury stock: Stocks that the company repurchased. This is often done to avoid hostile takeovers or to temporarily boost stock prices. However, shareholder equity is reduced by the amount of money spent to repurchase these stocks
• Unrealized gains and losses: The changes in pricing for investments that have not yet been cashed in. Unrealized gains occur when the investment increases in value but hasn’t been cashed in, while unrealized losses occur with a decrease in investment value
• Additional paid-up capital: The excess amount investors pay over the face value (aka par value) of the company’s stock

The statement of shareholders’ equity report is created with investors in mind, as it gives them important information and context into why their equity increases or decreases. It also alerts them to what is and isn’t working in the financials of the company, which may influence future investment decisions.