Types of Financial Statements

An entity’s financial statements generally consist of:

• A Profit and Loss Statement;
• A Balance Sheet; and
• A Cash Flow Statement

Each of these statements will be considered in turn.

Profit and Loss Statement

The profit and loss statement (or income statement) shows the profit or loss for the period. It is usually headed “for the year ended…”. Up until 30 June 2005, the profit and loss statement was also referred to as the statement of financial performance. The profit and loss statement includes:

• Revenues, and.
• Expenses of the business for the relevant period.

The difference between revenues and expenses is referred to as the net profit / (loss). Some organisations, particularly non-profit organisations, refer to this figure as the net surplus/(deficit). Net profit / (loss) is defined as:

Net profit / (loss)  =  Revenues  -  Expenses

Revenues are inflows derived by the entity as a result of the sale of goods or provision of services. Revenues typically include sales, interest received, rent received, dividends received, etc. Another term for revenue is income.

Expenses are day-to-day outflows incurred by the business in providing goods or services to customers. Expenses typically include advertising, accounting fees, bank charges, cleaning, electricity, insurance, interest paid, motor vehicle expenses, postage, printing and stationery, rent, salaries and wages, superannuation and telephone.

The profit (or loss) in the profit and loss statement is ultimately transferred to the equity section of the balance sheet (under the account entitled “current year profit”). Over the years, the accumulated profit is referred to as “retained profits”. Alternatively, if this account represents losses, it is referred to as “accumulated losses”.

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Balance Sheet

The balance sheet reports the entity’s:

• Assets.
• Liabilities.
• Equity.

Assets are defined as future economic benefits owned or controlled by the entity.  Assets are essentially anything owned by the entity that is valuable and contributes to revenue generation. Assets typically include cash at bank, accounts receivable, inventory, land and buildings, and plant and equipment.

Assets are usually classified as either current or non-current assets. If an asset is expected to be “realised” (or converted into cash) within the next 12 months, it is classified as a current asset. Conversely, if an asset is not expected to be converted into cash within the next 12 months, it is classified as a non-current asset in the balance sheet.

Liabilities are defined as future “sacrifices” of economic benefits that the entity is presently obliged to make to other entities. Essentially, liabilities are amounts owed by the entity to external parties. Liabilities typically include bank overdrafts, accounts payable, provision for annual leave and long service leave, tax liabilities and loans payable.

Once again, liabilities are classified as either current or non-current. If a liability is expected to be settled (or paid) within the next 12 months, it is classified as a current liability. Conversely, any liability not expected to be settled within the next 12 months is classified as a non-current liability in the balance sheet.

Equity is generally made up of:

• Capital;
• Retained profits (or accumulated losses); and.
• Reserves.

Equity represents the investments (both initial and ongoing) made by the owners of the entity and the sum of accumulated profits made over the years. The higher the equity, the more the business is worth. When a business makes a profit, equity increases. Conversely, if a business makes a loss, this has the effect of decreasing equity.

Following is a summary of useful accounting formulae:

Total assets = Current assets + Non-current assets

Total Liabilities = Current Liabilities + Non-current liabilities

Net assets = Total assets – Total liabilities

Net assets is also referred to as equity

Equity = Assets – Liabilities

Net profit/(loss) = Revenues – Expenses

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Cash Flow Statement

A cash flow statement reports the cash position of the entity during the reporting period. It is usually headed “for the year ended…”. Preparation of a cash flow statement has been required in Australia since 30 June 1992.

The cash flow statement reports the cash inflows and cash outflows of the business during the financial year. The cash flow statement reconciles the amount of cash on hand at the beginning and end of the reporting period.

Cash flows are broken down into three components:

• Cash flows from operating activities;
• Cash flows from financing activities; and
• Cash flows from investing activities.

The most important activity is cash flows from operating activities. In essence, these are the cash inflows and cash outflows from day-to-day activities (or cash profit).

Whilst the profit and loss statement shows revenues and expenses under accrual accounting principles, the cash flow statement is prepared under cash accounting concepts (i.e. cash in and cash out). For this reason, many people consider the cash flow statement to be more useful than the profit and loss statement.

Whilst cash flow statements are often included in external financial statements, they are not usually prepared by bookkeepers.

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