Understanding the Four Key Financial Statements
Share this article:
Being able to assess the health of a business is a crucial skill. For that you’ll need to understand what
the four basic financial statements in any business report will really be telling you.
1. Balance Sheet
The balance sheet tells you about the resources of a company. It lets you know how strong a
position it is in and how well equipped it is you meet all its obligations.
The balance sheet comprises three components: assets, liabilities and equity.
Assets can be current or long term. Current includes anything that can quickly be turned into cash
such as inventory, cash, securities and accounts receivable. Long term assets refer to buildings and
land which it may have purchased some time ago.
Meanwhile liabilities include all the company’s financial obligations such as wages, taxes, property
rent and debt, and equity refers to the owner’s equity in the business.
2. Income statement
This is the result of the business’ day to day operations and focuses on revenue and expenses.
Revenue can include any money coming into the business such as through the sale of a product, the
provision of services or other income such as the sale of property. Expenses will include every
outgoing from the regular money spent on wages and taxes as well as investment in new equipment
or personnel. By comparing the two you will get a basic idea of how profitable a company is.
3. Statement of Owner’s Equity
This statement shows the owner’s capital at the start of the period, the changes that affect capital,
such as withdrawal of capital by an owner, and the capital at the end of the period. Capital will be
increased by net income which means income minus expenses. If expenses are more than income
this will have an overall negative effect on capital.
4. Cash flow statement
Last but by no means least is the cash flow statement. This shows you the true picture of what
money is flowing in and out of the business. This is crucial because it tells you if a company can pay
its bills and if it is going to run short of money at some point.
This should be regularly reviewed as it’s perfectly possible for a company to be highly profitable but
to run out of money simply because the money doesn’t come in on time. In many ways, therefore,
this is the truest statement of a company’s health.
Enrolling in a professional qualification such as the CFA or CPA will get you up to speed on you
financial statements and turn you into an expert in no time!