Company Financial Statements | Overview, Analysis & Examples – Video & Lesson Transcript | Study.com
Company Financial Statements
Financial statements are used by companies to convey information related to their business activities and financial performance. Company financial statements are summary-level reports that carry a series of financial information such as the organization’s financial results, cash flow, financial position, and others. It is important to note that all companies must record and publish their financial statements. For instance, the Securities and Exchange Commission (SEC), which is an agency that oversees operations within the stock market in the US, requires companies to publish their financial statements on a quarter and annual frequency. In addition to publishing company financial reports, the SEC also requires publicly listed companies to audit them by a third party.
Business organizations need to prepare financial statements on the basis of the generally accepted accounting principles (GAAP) of the country where they perform. These financial statements are submitted to the authorities of concern and are usually found in the companies’ websites or in the capital market website. Analysts and investors use these reports for many reasons, such as:
- Assess the business organization’s ability to generate cash;
- Determine the sources and uses of cash;
- Track the financial performance of companies through time;
- Derive financial ratios to assess the financial health of companies.
The following sections will present four main financial statements prepared by nearly all publicly held organizations that are: the balance sheet, the income statement, the statement of cash flow, and the statement of retained earnings.
The Income Statement
The income statement, which is also referred to as the profit and loss statement, is a financial statement that reports the financial performance of a company during a specific period. This statement focuses on revenues earned and expenses incurred by the company. The income statement is used by internal and external stakeholders. Internal users include the management and board of directors while external users include investors, creditors, and competitors. Investors use the income statement to assess the company’s ability to earn profits and grow in the future. For creditors, the income statement is used to identify whether the company can generate enough money to payout debt or take additional loans. But for competitors, this financial report is used to have an overview of the company’s spending (e.g., how much the company is spending on research and development).
The income statement conveys information related to four key items that are: revenues, expenses, gains, and losses. First, revenues refer to the income generated from the company’s main activities such as the selling of goods/services. Second, expenses are cash outflows or the costs associated with generating revenues such as the cost associated with the purchase of raw materials. Finally, gains and losses occur when a business organization earns an income or incurs a cost based on the sale of an asset. It is essential to highlight that both gains are losses are cash inflows, and outflows resulted from secondary activities.
To calculate the net income, or net earnings, which is the profit that remained after deducting all expenses from revenues generated from sales, the following formula is used:
$$Net income = (Total Revenues + Gains) – (Total Expenses + Losses) $$
In addition to the net income, the income statement also reports the earning per share, which is another profitability measure. The earnings per share (EPS) calculates the earnings generated per each outstanding share of the company and is calculated using the following formula:
$$Earnings per share = (Net income – Dividends on Preferred Stock) / Average Outstanding Shares $$
Where:
- Dividends on preferred stock are dividends paid to the owners of preferred stocks;
- Average outstanding stocks are the total number of common shares that the company issued.
Statement of Retained Earnings
The statement of retained earnings shows the changes in the retained earnings account during a specific period. It is important to understand the way a company manages its generated profits. These retained earnings show the amount of profit that is not distributed among the company’s owners. In other words, it identifies the share of profit that the management retains to be plowed back in the company to finance future operations or future projects. The ending retained earnings after a specific period are calculated using the following formula:
$$Ending Retained Earnings = Beginning Retained Earnings + Net Income – Dividends $$