Financial Statements of a Company
Financial statements are critical reports prepared by a company’s management to present its financial performance and position at a specific point in time. Typically, a general-purpose set of financial statements includes a Profit and Loss Statement, a Balance Sheet, and a Statement of Cash Flows. These statements are essential for decision-makers because they provide comprehensive and accurate financial information. Companies are evaluated based on their past, current, and projected performance.
Profit & Loss Statement (P&L)
The Profit & Loss Statement, or Income Statement, captures revenues and expenses incurred from both operating and non-operating activities over a specific period, such as a month, quarter, or financial year. The basic formula is: Profits = Revenues – Costs. This statement follows the accrual method of accounting, meaning revenues and expenses are recognized when incurred, not necessarily when cash is exchanged. Major components include:
- Net Revenue/Net Sales: Sales made after returns or discounts.
- Cost of Goods Sold (COGS): Direct costs of producing goods or services.
- Gross Profit: Net Sales minus COGS.
- Operating and Direct Expenses: Costs directly attributable to the sale of goods/services.
- General and Administrative Expenses (G&A): Day-to-day operational costs.
- Employee Benefit Expenses: Compensation for employees.
- Operating Profit (EBITDA): Earnings before interest, taxes, depreciation, and amortization.
- Depreciation and Amortization: Costs of using long-term assets over time.
- Earnings Before Taxes (EBIT): EBITDA plus non-operating income minus depreciation and amortization.
- Interest Expenses: Costs incurred from borrowing.
- Profit Before Taxes (PBT): EBIT minus interest expenses.
- Profit After Tax (PAT): PBT minus taxes.
Balance Sheet
The Balance Sheet provides a snapshot of a company’s assets, liabilities, and shareholders’ equity at a specific point in time. The fundamental equation is: Total Assets = Total Liabilities + Shareholders’ Equity. Major classifications include:
- Non-Current Assets: Long-term investments like property and equipment.
- Current Assets: Short-term assets like cash and inventory.
- Shareholders’ Equity: The value of investors’ stakes in the company.
- Non-Current Liabilities: Long-term obligations like loans.
- Current Liabilities: Short-term obligations like accounts payable.
Cash Flow Statement
The Cash Flow Statement shows the inflow and outflow of cash and cash equivalents from operating, investing, and financing activities over a specific period.
- Operating Activities: Cash from primary revenue-generating activities.
- Investing Activities: Cash from the purchase and sale of long-term assets.
- Financing Activities: Cash related to borrowing and equity activities.
Analyzing Financial Statements
Analyzing financial statements involves various methods, such as ratio analysis, horizontal and vertical analysis. These techniques help in evaluating a company’s operational efficiency, liquidity, profitability, and solvency. Key ratios include liquidity ratios (current ratio, quick ratio), profitability ratios (gross profit ratio, net profit ratio), solvency ratios (debt-equity ratio, interest coverage ratio), and turnover ratios (inventory turnover ratio, receivables turnover ratio).
Understanding financial statements and their analysis is crucial for stakeholders to make informed decisions regarding the company’s performance and potential growth.
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