What are financial statements?
Financial statements can be broken down into 3 basic statements, Income Statement, Balance Sheet, and Statement of Cash Flow.
Income Statement
The Income Statement is also known as the Profit and Loss Statement. It shows the income and expenses of a business over a specific period of time. It can be broken down to 4 sections: income from operations, expenses for operations, non-operating income, and non-operating expenses.
1) Income from operations is any income from sales or services you do in your normal course of business such as selling t-shirts, mowing lawns, designing a website, etc. You can clump all the income together into one line, or if you want a better idea of what is generating the most income, have each item or service have its own line. If you sell physical items such as t-shirts, you will have the cost of each shirt and those costs are called cost of goods sold.
2) Expenses from operations are any expenses or costs it takes to run your business. If you own an office or store, the rent and utilities to run those spaces are expenses. If you drive to your client's home or office, then the gas, parking fee, and other car expenses are included in operating expenses. If you ship items to customers, the shipping and postage fees are part of operating expenses.
3) Non-operating income is any income you receive from sources other than normal operations. If you invest some of your business' money, any money received would be non-operating income. It could be money from a savings account, investment portfolios, or even selling off a big asset.
4) Non-operating expenses are any costs that are not related to your normal business activity. If you own a building, the depreciation on that building would be a non-operating expense. If you are investing or saving some money for the business, any expenses related to those activities are non-operating expenses.
Balance Sheet
The Balance Sheet shows a snapshot of how your business is doing at a specific point in time. Unlike the income statement, which shows how a business is doing over days/weeks/months, a balance sheet shows how a business is doing on a specific day. It can be broken down into 3 sections: assets, liabilities, and equity.
1) Assets are anything that the business owns or has rights to. The obvious asset would be cash you physically have in the business. Other assets are money in the bank, money your customers owe you, and money you have invested. Any property that your company owns is an asset, such as vehicles, machines, and buildings.
2) Liabilities are anything that the business owes to other people. Any sales tax you collect on products or services given is a liability because you have to pay the respective governments. If your business had credit cards or business loans, those are liabilities.
3) Equity is anything that would belong to the owners if the company was liquidated. It consists of any money invested by the owners or shareholders, along with any money distributed to them. This section also includes retained earnings, which is the total sum of all your income since the start of the business.
Statement of Cash Flow
Statement of cash flow lets you know how your money is moving around and if your money is moving smoothly. It shows the movement of money over a period of time. It can be broken down into 3 sections: operating activity, investing activity, financing activity.
1) Operating activity is any money that moves around in the normal course of business. It starts with the net income found in the Income Statements. It then adjusts non-cash accounts to show where the cash really came from and went.
2) Investing activities takes the end operating activities sum and adds and subtracts any money used for purchasing an asset or investing in stocks. Investing activities are similar to the non-operating income and expense section of the income statement.
3) Financing activities takes the sum of operating and investing activities and adds in any money borrowed from other people or businesses. It also subtracts any money given to owners, shareholders or the bank.