Three Financial Statements

The three financial statements are the income statement, the balance sheet and the cash flow statement.

What are the three financial statements?

The three financial statements are: (1) the Income Statement, (2) the Balance Sheet, and (3) the Cash Flow Statement.

The 3 core statements are intricately linked to each other and this guide will explain how they all fit together.

 

three financial statements infographic

 

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 revenue at the very top. The statement then deducts the cost of goods sold (COGS) to find gross profit. From there, the gross profit is affected by other operating expenses and income depending on the nature of the business to reach net income at the bottom.

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’ equity. As commonly known, assets must equal liabilities plus equity. The asset section begins with cash and equivalents, 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 earnings (adjusted for payment of dividends).

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 balances and ending balances 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

 Income StatementBalance SheetCash Flow
TimePeriod of timeA point in timePeriod of time
PurposeProfitabilityFinancial positionCash movements
MeasuresRevenue, expenses, profitabilityAssets, liabilities, shareholders' equityIncreases and decreases in cash
Starting PointRevenueCash balanceNet income
Ending PointNet incomeRetained earningsCash balance

 

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 models 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 is followed by 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 statement 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 schedule is used to calculate interest expense and the balance of debt items. The depreciation and amortization schedule is used to calculate depreciation expense and the balance of long-term fixed assets. These values will flow into the three main statements

 

More resources related to the 3 financial statements

We hope this has been a helpful overview for you of the 3 financial statements, and we believe these articles will help supplement your learning: