The language that helps connect much of the finance world and its actors together is accounting!
Like the rules that govern any language, accounting rules require that financial information is recorded in financial statements. In this series of #financialbasics, we'll learn about the three most important ones, namely the income statement, the balance sheet, and the cashflow statement.
THE INCOME STATEMENT
An income statement is one of the three important financial statementsused for reporting a company's financial performance over a specific accounting period, with the other two key statements being the balance sheet and the statement of cash flows.
Also known as the profit and loss statement or the statement of revenue and expense, the income statement primarily focuses on the company’s revenues and expenses during a particular period.
If you want to assess a company's financial health at a point in time, look at the balance sheet. It enables you to see whether a company’s assets are heavily funded by debt or equity, and to consider whether this is risky or not.
The three components of the balance sheet are Assets, Liabilities and Equities. It is called a balance sheet because Assets must equal Liabilities plus Equity.
The reason these two sides need to be in balance is quite intuitive - a company’s uses of funds, called assets, such as computers, raw materials or desks, must equal the company's sources of funds, which are the funds used to pay for these assets. These includes liabilities - including debt - and the shareholders' equity, which is equity capital that they have received from investors, or value which is leftover after the liabilities have been paid off. Liabilities include everything that a company owes, so debt and also money that is owed to suppliers.
CASH FLOW STATEMENT
A business receives (and makes) cash payments very often, so it is useful to have a separate, well-organised statement of everything in more detail. The cash flow statement is just that! Without cash, a company won’t be able to pay anyone it owes, and would cease to exist. In this sense, it’s even more important than profit, which is measured by the income statement.