the three types of financial statements

What are the Three Types of Financial Statements?

The primary three types of financial statements are the balance sheet, the income statement, and the cash flow statement. Each offers unique details about a business’ activities and together provide a comprehensive view of a company’s operating activities. We’re going to explain each and show you how these three types of financial statements all fit together.

The Balance Sheet

The first of the three types of financial statements is the balance sheet. The balance sheet provides a snapshot of a company’s financial position at a given point in time. It shows the company’s assets (what the company owns), liabilities (what it has borrowed), and shareholders’ equity (investment and retained earnings).

These numbers should balance each other out: Assets = Liabilities + Equity.

A balance sheet can be prepared daily, weekly, monthly, quarterly, or annually. Many small businesses prepare their balance sheets monthly, perhaps quarterly for smaller businesses.

Analysts can use a balance sheet to identify the health of a company using metrics such as the Current Ratio and Debt/Equity Ratio.

The Income Statement

The income statement is sometimes called the Profit and Loss statement (or P&L). The income statement shows the revenue a company earns and the expenses involved in its operating activities.

The difference between revenue and expenses represents the company’s net profit for a given period of time.

It does this by showing the sales revenue at the top and then deducting direct and indirect expenses.

Direct expenses are your cost of goods sold (COGS). This provides us with gross profit. Indirect expenses include operating expenses (salaries, administrative expenses, research and development, etc.) and secondary activity expenses such as interest paid on loans taxes.

The result is a company’s net income.

Net income at the end of a period becomes part of the shareholders’ equity feeding the balance sheet. Net income is also carried over to the cash flow statement

When analyzing the income statement, you should be looking at the company’s profitability using key ratios like gross margin, operating margin, and net margin as well as tax ratio efficiency and interest coverage.

The Cash Flow Statement

A cash flow statement shows how much cash enters and leaves your business over a set period of time. It begins with the net income from the income statement and subtracts any non-cash expenses.

The cash flow statement shows cash coming and going out of the business in three categories:

  • Operating: Including revenue, expenses, gains, losses, and other costs.
  • Investing: Debt and equity purchases and sales; purchases of property, plant, and equipment; and collection of principal on debt, etc.
  • Financing: Including paying or securing long-term loans, sale of company shares, and payment of dividends.

The cash flow statement shows the change in cash per period, as well as the beginning balance and ending balance of cash.

Now that you have an overview of the three types of financial statements, let’s look at how they fit together to give you a really clear picture of the state of your business. This diagram from the Corporate Finance Institute does a good job of illustrating the similarities and differences between the three types of financial statements, and showing you where they intersect:

 Income StatementBalance SheetCash Flow
TimePeriod of timeA point of timePeriod of time
PurposeProfitabilityFinancial PositionCash Movements
MeasuresRevenue, expenses, profitabilityAssets, liabilities, shareholders’ equityIncreases and decreases in cash
Starting PointRevenueCash balanceNet income
Ending pointNet incomeRetained earningsCash balance
Source: The Corporate Finance Institute

Learn more about how to read and understand financial statements in How to Read Financial Statements: A Guide for Business Owners.

Disclaimer: Avisar Chartered Professional Accountant’s blog deals with a number of complex issues in a concise manner; it is recommended that accounting, legal or other appropriate professional advice should be sought before acting upon any of the information contained therein. Although every reasonable effort has been made to ensure the accuracy of the information contained in this post, no individual or organization involved in either the preparation or distribution of this post accepts any contractual, tortious, or any other form of liability for its contents or for any consequences arising from its use.