Basics of Financial Statements Prepared by Companies
Financial statements are like the financial dashboard of a business, providing vital insights into the company’s financial health. These statements not only offer a snapshot of a company’s financial position but also help business owners and management make informed decisions for future actions. Although small businesses may not always be fully aware of these statements, larger companies are usually quite familiar with them. Financial statement preparation often takes place when filing income tax returns, and businesses in the UK are required to submit specific financial statements depending on the size of the company. Despite the variety of accounting statements that companies may need to prepare based on their needs, there are a few fundamental financial statements that are universally essential. These statements are critical regardless of the size of the company.
Key Financial Statements Commonly Prepared by Businesses
1. Balance Sheet
The balance sheet is an important financial statement that shows the company’s financial position at a particular moment in time. It has two main parts:
Assets: This lists everything the company owns that is expected to bring value in the future. Assets are divided into two types: current assets, like cash, accounts receivable (money owed to the company), and inventory (goods for sale), which are expected to be turned into cash within a year; and non-current assets, like buildings, equipment, and long-term investments, which are used for more than a year.
Liabilities and Shareholders’ Equity: Liabilities are divided into current liabilities (debts to be paid within a year) and non-current liabilities (debts due after more than a year). Shareholders’ equity represents the value left for the owners after subtracting liabilities from assets. It includes the money shareholders have invested and any profits that have been kept in the business.
2. Income Statement
The income statement, also known as the profit and loss (P&L) statement, is another essential financial document that shows the company’s performance over a specific period, typically a quarter or year.
Revenue: The income earned by the company from its normal business operations, such as sales of products or services. It is usually the first item listed on the income statement.
Expenses: Expenses can include cost of goods sold (COGS), administrative expenses, marketing costs, salaries, rent, utilities, and depreciation.
The difference between revenue and expenses is the net income, also referred to as profit or loss. If the company’s expenses exceed its revenue, it will show a net loss for the period.
3. Cash Flow Statement
The cash flow statement is another fundamental financial statement that tracks the flow of cash in and out of the business.
Operating Activities: This section includes cash inflows and outflows related to the core business operations, such as receipts from customers and payments to suppliers or employees. It also includes adjustments for non-cash items like depreciation.
Investing Activities: This section tracks cash spent on or received from investments, such as purchasing or selling long-term assets like property, equipment, or investments in other companies.
Financing Activities: This section reports the inflows and outflows related to raising capital and paying back debt. For example, issuing new shares or borrowing money increases cash flow, while repaying loans or paying dividends reduces cash flow.
The net cash flow from all three activities (operating, investing, and financing) is the final result, which shows whether the company has a positive or negative cash flow for the period.
The cash flow statement is important because it helps stakeholders understand how well a company manages its cash to fund operations, pay debts, and invest in future growth. A company could be profitable on paper but still face liquidity problems if it does not manage its cash flow effectively.
4. Statement of Changes in Equity
Although not as commonly discussed as the balance sheet, income statement, or cash flow statement, the statement of changes in equity provides valuable insight into the company’s financial activities. This statement explains the changes in the company’s equity during a given period. It reflects how profits, losses, dividends, and capital contributions affect the business’s ownership structure and retained earnings.
The statement of changes in equity includes:
Retained Earnings: The portion of profit that is not distributed as dividends but kept in the company for reinvestment.
Share Capital: Funds raised by issuing shares to the shareholders.
Other Reserves: Funds set aside for specific purposes, such as legal or general reserves.
This statement helps business owners and investors understand how the company’s equity position has changed over time, including the impact of profits, losses, and dividends on the company’s overall financial standing.
Conclusion
For businesses that find it challenging to prepare high-quality financial statements, outsourcing to accounting professionals can be a smart solution. Accounting experts are skilled in preparing accurate and compliant financial reports, ensuring that all regulations are met and the statements are presented in an easy-to-understand format.
Meru Accounting is one such service provider that specializes in creating these financial statements for companies. With qualified professionals who are well-versed in UK regulations, Meru Accounting can prepare accurate financial statements that provide clear financial insights. These statements can assist businesses in managing their financial position effectively and making informed decisions for future growth.