The key components of financial statements

Financial statements give stakeholders a comprehensive picture of a company’s financial health

Depending on the stakeholder, the financial statements will be a useful tool in answering pressing questions about a company you work for, a company you have invested funds in or a company you have extended credit to.

A set of financial statements consists of four statements, including a statement of financial position, statement of profit or loss, statement of changes in equity and a statement of cashflows.

Key components of financial statements

Statement of financial position

Also known as the balance sheet statement. This statement shows a company’s assets, liabilities and equity at a specific point in time. Depending on the type of business and its operations; assets, liabilities and equity will be important to a stakeholder of the company for various reasons.

The statement of financial position has three subsections. First, the total assets of the company which relate to the resources that the company controls, both tangible and intangible. These are used to derive positive economic value for the company. Second is the liabilities, which is what the company owes to third parties. Most of the time, these liabilities are incurred to purchase the resources required for the company to operate. Lastly, you have the equity which represents the net worth of the company from the shareholder’s perspective. A user of the financial statements may be interested in how a company is using its assets effectively and efficiently for its operations and in the generation of profits. On the other hand, another user may be interested in the company’s debt management and financing strategies evidenced by the liabilities and equity mix.

Statement of comprehensive income

Also known as the profit or loss or income statement. This statement shows the profit or loss made by a company after all revenues and expenses have been accounted for. It would show stakeholders how much revenue was generated from the resources invested in the business, how effectively the costs are managed and ultimately how much profit was generated for that year/specific period.

Statement of changes in equity

This statements details changes in equity over a period of time due to net income or loss, dividend payments., share capital movements and other equity transactions. It is a great indicator of what the investors’ equity is throughout a specific period.

Statement of cashflows

This statement helps stakeholders understand how a company generates and utilises its cash. It categorises the activities a company can partake in to generate or utilise cash in three broad categories, namely: investing, operating and financing activities.

A healthy cash balance is vital to the survival of the entity. It is also a tricky concept because the balance cannot be too high or too low. An extremely high cash balance could be indicative of a company’s inability to make sound investment decisions to grow the business operations. In the same light, an extremely low balance, though perceived as bad, could indicate sound long-term investment decisions which is positive for future growth. It is also important to remember to remain cognisant of the company’s phase of growth

The importance of financial statements

The beauty of financial statements is that they tell a story about the company’s financial health without speaking to management. For example, if a company purchases new equipment, one expects to see the effect in the statement of financial position through an increase in the assets. Depending on how it was financed, a corresponding increase in the liabilities or decrease in the cash balance would be noted. This transaction would also need to reflect on the statement of cash flow as an investing activity. As the equipment is used, depreciation would be recognised and presented on the statement of profit and loss. This expense would form part of the calculation required to calculate the net profit or loss for the year which is then carried into the statement of changes in equity.

The financial statements are integrated, communicate a combined story and underpin the principles of the accounting equation.

Zizipho Nodada

Company Statutory Auditor, Johannesburg