Three Financial Statements

What are the three financial statements?

The three financial statements are: (1) the Income StatementIncome StatementThe Income Statement (or Statement of Profit and Loss) shows performance from operations of a business. The financial statement begins with revenues and, (2) the Balance SheetBalance SheetThe balance sheet is one of the three fundamental financial statements. These statements are key to both financial modeling and accounting. The balance sheet displays the company’s total assets, and how these assets are financed, through either debt or equity. Assets = Liabilities + Equity, and (3) the Cash Flow StatementStatement of Cash FlowsThe Statement of Cash Flows is one of the 3 key financial statements that reports the cash generated and spent during a specific time period, it acts as a bridge between the income statement and balance sheet. These three core statements are intricately linked to each other and this guide will explain how they all fit together. By following the steps below you’ll be able to connect the three statements on your own.

Overview of the three financial statements:

#1 Income statement

Often, the first place an investor or analyst will look is the income statement. The income statement shows the performance of the business throughout each period, displaying sales revenueSales RevenueSales revenue is the starting point of the income statement. Sales or revenue is the money earned from the company providing its goods or services, income at the very top. The statement then deducts the cost of goods sold (COGSCost of Goods Manufactured (COGM)Cost of Goods Manufactured (COGM) is a schedule showing the total production costs during a specific period of time. See COGM formula & examples in this guide. COGM is the total costs incurred to manufacture products and transfer them into finished goods inventory for actual retail sale) to find gross profitGross ProfitGross profit is the direct profit left over after deducting the cost of goods sold or cost of sales from sales revenue. It's used to calculate the gross profit margin and is the initial profit figure listed on a company's income statement. Gross profit is calculated before operating profit or net profit.. From there, the gross profit is affected by other operating expenses and income, depending on the nature of the business, to reach net incomeNet IncomeNet Income is a key line item, not only in the income statement, but in all three core financial statements. While it is arrived at through the income statement, the net profit is also used in both the balance sheet and the cash flow statement. at the bottom – “the bottom line” for the business.

Key features:

• Shows the revenues and expenses of a business
• Expressed over a period of time (i.e. 1 year, 1 quarter, Year-to-Date, etc.)
• Uses accounting principles such as matching and accruals to represent figures (not presented on a cash basis)
• Used to assess profitability

#2 Balance sheet

The balance sheet displays the company’s assets, liabilities, and shareholders’ equityStockholders EquityStockholders Equity (also known as Shareholders Equity) is an account on a company's balance sheet that consists of share capital plus retained earnings. It also represents the residual value of assets minus liabilities. By rearranging the original accounting equation, we get Stockholders Equity = Assets – Liabilities. As commonly known, assets must equal liabilities plus equity. The asset section begins with cash and equivalentsCash EquivalentsCash and cash equivalents are the most liquid of all assets on the balance sheet. Cash equivalents include money market securities, Bankers Acceptances, Treasury bills, commercial paper, and other money market instruments., which should equal the balance found at the end of the cash flow statement. The balance sheet then displays the changes in each major account. Net income from the income statement flows into the balance sheet as a change in retained earningsRetained EarningsThe Retained Earnings formula represents all accumulated net income netted by all dividends paid to shareholders. Retained Earnings are part of equity on the balance sheet and represent the portion of the business’s profits that are not distributed as dividends to shareholders but instead are reserved for reinvestment (adjusted for payment of dividendsDividend vs Share Buyback/RepurchaseShareholders invest in publicly traded companies for capital appreciation and income. There are two main ways in which a company returns profits to its shareholders – Cash Dividends and Share Buybacks. The reasons behind the strategic decision on dividend vs share buyback differ from company to company).

Key features:

• Shows the financial position of a business
• Expressed as a “snapshot” or point in time (i.e. as at December 31, 2017)
• Has three sections: assets, liabilities, and shareholders equity
• Assets = Liabilities + Shareholders Equity

#3 Cash flow statement

The cash flow statement then takes net income and adjusts it for any non-cash expenses. Then, using changes in the balance sheet, usage and receipt of cash is found. The cash flow statement displays the change in cash per period, as well as the beginning balance and ending balance of cash.

Key features:

• Shows the increases and decreases in cash
• Expressed over a period of time (i.e. 1 year, 1 quarter, Year-to-Date, etc.)
• Undoes all accounting principles to show pure cash movements
• Has three sections: cash from operations, cash used in investing, and cash from financing
• Shows the net change in cash balance from start to end of the period

Summary comparison

How are these 3 core statements used in financial modeling?

As explained above, each of these three financial statements has an interplay of information. Financial modelsWhat is Financial ModelingFinancial modeling is performed in Excel to forecast a company's financial performance. Overview of what is financial modeling, how & why to build a model. A 3 statement model links income statement, balance sheet, and cash flow statement. More advanced types of financial models are built for valuation, plannnig, and use the trends in the relationship of information within these statements, as well as the trend between periods in historical data, to forecast future performance.

The preparation and presentation of this information can become quite complicated. In general, however, the following steps are followed to create the financial model.

• Line-items for each of the core statements are set up. This provides the overall format and skeleton that the financial model will follow
• Historical numbers are placed in each of the line-items
• At this point, the creator of the model will often check to make sure that each of the core statements reconciles with data in the other. For example, the ending balance of cash calculated in the cash flow statement must equal the cash account in the balance sheet
• An assumptions section is prepared within the sheet, to analyze the trend in each line-item of the core statements between periods
• Assumptions from existing historical data are then used to create forecasted assumptions for the same line items
• The forecasted section of each core statement will use the forecasted assumptions to populate values for each line item. Since the analyst or user has analyzed past trends in creating the forecasted assumptions, the populated values should follow historical trends
• Supporting schedules are used to calculate more complex line items. For example, the debt scheduleDebt ScheduleA debt schedule lays out all of the debt a business has in a schedule based on its maturity and interest rate. In financial modeling, interest expense flows into the income statement, closing debt balance flows onto the balance sheet, principal repayments flow through the cash flow statement, completing the scheudle is used to calculate interest expense and the balance of debt items. The depreciation and amortization scheduleDepreciation ScheduleA depreciation schedule is required in financial modeling to forecast the value of a company's fixed assets (balance sheet), depreciation expense (income statement) and capital expenditures (cash flow statement). In financial modeling, a depreciation schedule is requried to link the three financial statements in Excel is used to calculate depreciation expense and the balance of long-term fixed assets. These values will flow into the three main statements

Screenshot from CFI’s financial modeling courses.

More resources related to the 3 financial statements

We hope this has been a helpful overview for you of the 3 financial statements. CFI is the official provider of the global Financial Modeling & Valuation Analyst (FMVA)™FMVA® CertificationThe Financial Modeling & Valuation Analyst (FMVA)® accreditation is a global standard for financial analysts that covers finance, accounting, financial modeling, valuation, budgeting, forecasting, presentations, and strategy. certification program, designed to help anyone become a world-class financial analyst. Through financial modeling courses, training, and exercises, anyone in the world can become a great analyst. To continue learning, explore these additional resources:

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