Five elements of the financial statement include the balance sheet, income statement, statement of cash flow, statement of changes in equity, and the notes to the financial statements.
Financial statement definition
A financial statement is a report that provides a comprehensive set of financial status, financial performance, operational performance, and detailed notes relevant to business understanding and performance.
Financial information is structurally presented in terms of assets, liabilities, and equity to give a fair idea of status and ongoing performance. Auditors audit financial information to increase its reliability and reliance on the user. Financial statements are usually provided with the previous year’s figures that enable the user to assess if the business’s current performance is getting impaired/improved.
It’s important to note that financial statements are prepared based on the International Accounting Standard or US GAAP depending on the business’s geographical location. These sets of accounting principles slightly differ in their accounting treatment and presentation of financial information.
Nearly all business stakeholders, like shareholders, lenders, employees, Government, suppliers, stock exchange, tax authorities, major suppliers, major customers, and potential investors, make use of the financial statement.
The financial statement of the public company is easily available on their website, whereas the financial statement of a private entity has to be requested. In most jurisdictions, public companies are required by law to publish financial statements on a quarterly/semi-annually/annually basis.
Also read, what is financial accounting
Five types /components of financial statement
Generally, there are five types of financial statements: a balance sheet, income statement, statement of comprehensive income, statement of cash flow, statement of changes in equity, and notes to the financial statement (an integral part of the financial statement).
1) Balance sheet
The new name of the balance sheet in the world of accounting is a statement of financial position. That’s because it shows the financial position of the business at some specific date under consideration. The business’s financial position is reflected in terms of proportion for the assets, liabilities, and equity. For instance, if the business’s equity is in a higher proportion, the balance sheet is considered to be strong.
There is one misconception that the balance sheet with a higher proportion of the assets is considered strong that’s not true; there may be even higher liabilities than assets. So, we need to deduct liabilities from assets to assess the true potential of the business. Let’s discuss the nature of the items like assets, liabilities, and equity.
Assets are the economic resources controlled by the business. The assets may be current and non-current, depending on the expected period of use. The current assets include prepayments, cash in hand, receivables, finished goods, work in progress, raw material, petty cash, etc. On the other hand, non-current assets include property, plant & equipment, long-term receivables, long-term investments, and intangible assets like software amortized over the complete useful life.
Goodwill is also considered assets, not amortized, but the periodic check must be made to assess impairment. Further, equity and liability added up to get assets, and they increase with the debit while decrease with the credit.
Liabilities are the present obligations that are settled when economic benefits flow outside of the business. Liabilities can be current and non-current depending on the fact that when the economic benefit is expected to flow outside of the business if an economic benefit is expected to flow within twelve months, its current liability. Current liability includes trade payable, accrued liability, short-term loans, accrued profit on borrowing, interest payable, etc.
On the other hand, if the economic benefit is expected to flow in a time more than a year, it’s called non-current liability. The examples include long-term loans, long-term security deposits payable, and long-term other liabilities, etc.
Equity is the difference between assets and liabilities. If assets of the business are more than liabilities, equity is positive. On the other hand, if liabilities are more than assets, the equity is negative. So, the value of equity is dependent on the proportion of assets and liabilities. Hence, changes in assets/liabilities will impact the balance of equity.
The components of the equity balance include share capital, common stock, preferred stock, reserves, and retained earnings (accumulated profit).
Further, the amount of net equity changes with the inclusion of profit/loss of the current period in the opening balance of equity. Suppose current period profit is added in the opening equity, the net equity increases. On the other hand, if the loss for the current period is added in the opening retained earnings, the net equity decreases.
2) Income statement
An income statement is the structured presentation of the revenue and expenditure related to the specific period under consideration. The main components of the income statement include revenue, expenditure, and profit & loss.
If the revenue of the business is more than expenses, it results in profit for the business. Similarly, if the expenses are more than the revenue, it results in a loss for the business.
The new name of the income statement is a statement of financial performance. It’s so-called because it helps to understand the performance of the business under a specific period. The performance can be measured by comparing period to period comparison, competitor comparison, and industry trend, etc.
In addition to this, there are two acceptable formats of the income statement. The first is the single statement format, where the income statement and comprehensive statement are presented as a single sheet. At the same time, the second format is multi-statement, where the income statement and comprehensive income are presented separately.
Overall, there are three income statement components, including revenue, expenses, profit, or loss assessment. Let’s have a further understanding of these concepts.
Revenue refers to the generation of economic benefit by the business under a specific period. There can be multiple sources of revenue depending on the business activities. For instance, the business can generate revenue by selling wheat along with porridge. The business’s total revenue is shown as a single line item on the front of the income statement, while a breakup is provided in the notes to the financial statement.
Revenue by default is credit in nature and increases with business activities. On the contrary, sales return is debit in nature and decreases net revenue. Same goes with sales discount as leads to decrease in the net revenue. The breakup of revenue is provided as follows in the notes to the financial statement.
Gross revenue (Total revenue booked by the business) XXX
Sales return (Total revenue reversed by the business) XXX
Sales discount (Trade discount offered by business) XXX
Net revenue (Reported as summarized figures) XXX
Expenses refer to operational costs incurred by the business in a specific accounting period under consideration. Expenses are mapped in the income statement under different heads depending on the purpose of the expense. For instance, if the expenses are incurred to generate revenue directly, it’s classified in the cost of sales. On the other hand, if the expense is incurred to support the business, it’s classified as administrative. Similarly, the expense can also be classified as marketing depending on the benefit obtained.
Further, a single expense can also be mapped to different heads depending on the use. For instance, the amount paid for the machinery insurance can be proportioned in line with the use of machinery in different departments.
Similarly, interest on the loan and bank expenses are classified as finance expenses. And tax expense is included to arrive at the net profit.
2.3) Profit and loss
The bottom of the income statement contains profit/loss. If expenses of the business are more than the revenue, it’s a loss for the business. On the other hand, if revenue is more than expenses, it’s a loss for the business.
3) Statement of changes in equity
Statement of changes in equity shows the movement for equity. The profit/loss from the income statement is added to the opening retained earnings. Similarly, other capital transactions, like the issue of shares and payment of dividends, are reflected here.
Usually, the statement of changes in equity has the following format.
Opening capital XXX
Equity issued XXX
Add/Subtract profit XXX/ (XXX)
Dividend paid (XXX)
Treasury shares (XXX)
Net equity XXX/ (XXX)
4) Statement of cash flow
Statement of cash flow presents a complete picture of the cash flow movement, and it shows a complete breakup of the cash in or out of business. Cash flow activities are divided into three main headings: operating, financing, and investing activities.
Operating activities of the business contain cash movement related to normal business operations. Similarly, financing activities are about changes in the financing structure of the business—for instance, the collections/payment of the loan, dividend payment, treasury shares, etc.
Investing activities are concerned with the investment perspective of the business. These activities include the purchase of PPE, proceeds from the sale of PPE, purchase of marketable securities, sale of the business department, etc.
5) Notes to the financial statement
Notes to the financial statement are the mandatory disclosure in the financial statement of the business. The IFRS and GAAP require these disclosures; it enables the financial statement user to better understand the business and movement in the balance of line items.
The line items in the balance sheet, income statement, statement of changes in equity, and cash flow contain a reference for the numbering in the notes to the financial statement. It enables the user to get a more detailed understanding and breakup for the specific movement of the account balance/transaction.
The financial statement is an essential business document. Many stakeholders use it to understand the business, assess the financial conditions of the business, and understand the financial status. There are three components of a financial statement with different purposes as follows,
- Balance sheet – used to assess the financial position of the business.
- Income statement – Used to assess the financial performance of the business.
- Equity statement – Used to assess the movement of the equity/capital.
- Cash flow statement – Used to assess the movement of cash.
- Notes to FS – Used to understand the business and finance-related details.
Frequently asked questions for financial statement
Who makes use of the financial statement?
Different stakeholders of the business like shareholders, lenders, banks, Government, tax authorities, major suppliers, major customers, and potential investors use financial statements.
What are the five components of a financial statement?
Following are five parts of the financial statement.
- Balance sheet
- Income statement
- Cash flow statement
- Changes in equity
- Notes to financial statement
What are the five elements of a financial statement?
Five components of financial include followings,
What’s the difference between a balance sheet and an income statement?
The balance sheet is prepared as of the accounting period, and it’s used to assess the business’s financial health at the present moment. On the other hand, the income statement is used to assess the periodic performance of the business.
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