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Financial Statements

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Business Studies

What image comes to mind when you hear the term ‘financial statements'? Perhaps just a piece of paper with a ton of digits representing the monies in a business. Reviewing, assessing, and comparing financial statements, however, is crucially important for owners, shareholders, and interested parties in a business. Without financial statements, it would most likely be impossible to make any definitive statement about a company and its financial well-being. So what exactly are financial statements? Let's take a closer look.

Financial Statements: Definition

To understand what is included in a financial statement, let's first take a look at its definition.

A financial statement is a collection of data and figures organised according to recognised accounting principles.

Financial statements present various data and figures such as revenues, expenses, profits, losses, assets, liabilities, and equity. All of these data are organised according to accounting principles - rules and guidelines that companies must follow when reporting financial data.

Financial Statements Financial statement StudySmarterFinancial statement, canva.com

Why do businesses prepare financial statements?

There are numerous reasons why businesses prepare financial statements:

  • The law - In many countries financial statements are obligatory. For example, in the UK it is a legal requirement for companies to publish financial statements. Moreover, they have to be prepared according to recognised accounting standards and in an agreed format. Companies that fail to do so may be fined or even forced to shut down.

  • To help managers make decisions - Financial statements can be very useful for managers when making business decisions. For example, if they see that a company is making losses, they can refrain from spending money and try to introduce actions to improve profitability.

  • To guide investors - As financial statements provide information about profits or losses and the overall value of a company, they can be a useful guide for people and organisations considering investing in it. For example, when an investor decides on which firm to invest in, they can have a look at their financial statements and compare their profits.

What financial statements are there?

There are two main financial statements:

  • Income statements

  • Balance sheet

Financial Statements: Income statement

The income statement shows the profit earned and loss sustained by a business over a particular period (usually 12 months). It shows all revenues earned and expenses incurred during the specified period.

The income statement provides information on revenues that a business has incurred over a particular period of time. Revenue is money a company has earned from its sales.

At Sainsbury's, all the money customers pay when buying groceries, home articles, etc. is considered revenue for the company.

The income statement also provides information on expenses that a business has incurred over a particular period of time. An expense is money a company has spent to operate. Expenses can include costs related to manufacturing and selling products, interest, taxes, and any other expenses.

At Pret, all money the company spends on coffee ingredients such as coffee beans, milk, sugar, etc. is an expense associated with daily production.

The income statement matches all the revenues and expenses to show a profit or loss made by a business. This way it can arrive at a net profit which is the final feature of the income statement. Net profit is the profit made by a business after all of its expenses have been subtracted from revenues.

Financial Statements: Balance sheet

The balance sheet shows the assets and liabilities of a business at a specific point in time (usually the end of the financial period). It consists of assets, liabilities, and equity.

The balance sheet provides information on assets that a business possesses at a specific point in time. An asset is everything that a company owns.

At Amazon, all the warehouses a company owns are assets.

The balance sheet also provides information on liabilities that a business owes at a specific point in time. A liability is everything that a company owes.

Any loans and interest payments a company owes to a bank are liabilities.

The balance sheet matches all the assets and liabilities to show the equity of a business. This way it can arrive at total equity which is the final feature of the balance sheet. Total equity is a business's capital that belongs to shareholders. This is the money remaining after the business has subtracted liabilities from its assets.

Interpretation and analysis of financial statements

Different people involved or interested in a business might want to find out about its financial performance. In order to do so, they need to interpret and analyse its financial statements. There are several ways to interpret and analyse financial statements:

Financial Statements: Comparing with previous years

Comparing financial statements with those from previous years is typically the first thing owners, shareholders, managers, and others do to analyse the financial performance of a company. For example, looking at the income statements from previous years, one can see whether a firm’s profits have increased or decreased.

Financial Statements: Comparing with competitors

Another way to examine the financial performance is to compare the financial statements of a business with its competitors. For example, by looking at the balance sheets of competitors, one can assess whether a debt a firm owes is relatively big, small, or typical for businesses in the industry.

Financial Statements: Calculating financial ratios

To deeply analyse the financial performance of a business, it may be useful to take figures from its financial statements and calculate financial ratios that compare the relationship between two or more elements of financial data sourced from a business's financial statements. For example, one can take figures from the income statement to calculate the net profit margin - a ratio showing net profit as a percentage of revenue.

As you can see, financial statements are very helpful when analysing the financial performance of a business. The data and figures they include allow us to find out about the profitability and value of a business, which can be useful for managers and potential investors.

Financial Statements - Key takeaways

  • Financial statements are a collection of data and figures organised according to recognised accounting principles.
  • Businesses prepare financial statements because they are usually required by law, help managers make decisions, and guide investors.
  • The two main financial statements are the income statement and the balance sheet.
  • The income statement shows the profit earned and loss sustained by a business over a particular period (usually 12 months). It shows all revenues earned and expenses incurred during the specified period.
  • The final feature of the income statement is net profit, which is the profit made by a business after all of its expenses have been subtracted from revenues.
  • The balance sheet shows the assets and liabilities of a business at a specific point in time (usually the end of the financial period). It consists of assets, liabilities, and equity.
  • The final feature of the balance sheet is total equity, which is the amount of the business's capital belonging to shareholders. This is the money remaining after the business has subtracted liabilities from its assets.
  • Ways to interpret and analyse financial statements include: comparing with previous years, comparing with competitors, and calculating financial ratios.

Financial Statements

Financial statements are a collection of data and figures organised according to recognised accounting principles - rules and guidelines that companies must follow when reporting financial data. They present various data and figures such as revenues, expenses, profits, losses, assets, liabilities and equity.

Financial statements are important because of various reasons. They might be required by law in a specific country but they are also helpful for managers when making decisions. They also guide potential investors.

Some ways to interpret and analyse financial statements include comparing with previous years, comparing with competitors and calculating financial ratios.


The two main financial statements are the income statement and the balance sheet. The income statement shows the profit earned and loss sustained by a business over a particular period (usually 12 months). It shows all revenues earned and expenses incurred during the specified period. The balance sheet shows the assets and liabilities of a business at a specific point in time (usually the end of the financial period). It consists of assets, liabilities, and equity.

In many countries financial statements are obligatory. For example, in the UK it is a legal requirement for companies to publish financial statements. 

Final Financial Statements Quiz

Question

What is a balance sheet? 

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Answer

A balance sheet shows what the company owns and owes to others at a certain point in time. 

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What are the three main components of a balance sheet?

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Answer

assets, liabilities, and equity

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What are assets?

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  • Assets are what the company owns such as buildings, stock, or cash.  

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What are liabilities?

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Liabilities are what the company owes to creditors and banks such as bank loans or unpaid bills.  

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What is equity?

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Equity is anything invested in a company by its owners. 

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What is included in total assets? 

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Fixed assets and current assets

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What are fixed assets? Give some examples. 

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Fixed assets are a company’s possessions that are not going to be sold. They tend to last for a long time and are used to produce goods or services. 


e.g. building, land, computers, equipment. 

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What are current assets? Give some examples. 

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Current assets are a company’s possessions that are used in production. They tend to be held for a short period of time. 


e.g. Cash, inventory, stock, accounts receivable 

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What is included in total liabilities? 

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current and long-term liabilities

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What are current liabilities?

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Current liabilities are what a business owes in the short-run (due within one year)

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What are long-term liabilities? 

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Long-term liabilities are what a business owes in the long run (not due in the near future)

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What is the formula to calculate the overall wealth of a business?

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Net assets = fixed assets + current assets - current liabilities - long-term liabilities 

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What is the equation of a balance sheet? 

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Net assets = Total Equity

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What is not a fixed asset? 

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Machinery

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What is a long-term liability? 

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Bank loans of more than a year

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Question

What is dividend payment? Is it a liability or an asset?

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Dividends are profits distributed to shareholders. 


Dividends are a current liability. 

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Is stock traded on a stock exchange a fixed or current asset? 

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Current asset

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What is an income statement?

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An income statement is a type of financial statement that shows a company's financial situation during a specific period.

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What does an income statement show?

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The income statement reveals a company's revenue, expense, and profit during a certain period of time. 

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What are the features of an income statement?

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Features of an income statement include revenue, cost of sale, gross profit, overheads, operating profit, tax and interest payments, and net profit.

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Is an income statement a type of financial statement?

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Yes, an income statement is a type of financial statement.

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What's the difference between the income statement and the balance sheet?

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It's important to understand that the income statement gives the overall financial picture of a company throughout a period of time, as opposed to the balance sheet, which provides an overview of the business' finances on a specific date.

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Does the income statement show the financial situation of a company on a certain date?

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No, income statement shows how well a company is doing throughout a certain period in time.

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Under which act is every company in the UK required to disclose their income statement?

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Every company in the UK is required by law to publish their income statement under the Companies Act.

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When is income statement important for managers?

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The income statement is often crucial when managers decide whether they want to expand into new areas or increase their manufacturing capabilities.


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Define revenue.

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Revenue refers to the income the business makes by selling goods or services. The income statement shows the revenue made over a certain period. Revenue includes the total income made throughout that period.


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Define cost of sales.

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Cost of sales includes every cost that a company makes in the process of producing goods and services. These costs involve the salaries that a business has to pay to its workers, including the cost of raw materials, and the cost of the building and its maintenance. 

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What is gross profit?

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Gross profit is the difference between the revenues and the cost of sales.

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What's the formula for gross profit?

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The formula for gross profit is,

gross profit= revenue- the cost of sales.

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Define overheads.

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These are similar to fixed costs as they do not change in the short term. Regardless of the volume of production, these costs will remain steady. Such costs include the building where the manufacturing occurs, interest paid on loans, insurance costs, etc.

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Define operating revenue.

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Operating revenue is the difference between a company's gross revenue and its overheads.

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What is the formula of operating revenue?

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The formula for operating revenue is: Operating revenue = Gross profit – operating revenue.


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Define net profit.

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Net profit is one of the most important measurements of how well a business is doing. It's the final feature of an income statement, and it basically shows all the money that's left for the business to take home. 

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What are the financial statements?

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Answer

Financial statements are a collection of data and figures organised according to recognised accounting principles.


Show question

Question

What are the accounting principles?


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Answer

rules and guidelines that companies must follow when reporting financial data

Show question

Question

What are the three reasons why companies prepare financial statements?


Show answer

Answer

  • The law
  • To help managers make decisions
  • To guide investors

Show question

Question

Are financial statements obligatory in the UK?


Show answer

Answer

Yes

Show question

Question

What financial statements are there?


Show answer

Answer

  • Income statement
  • Balance sheet

Show question

Question

What is the income statement?


Show answer

Answer

The income statement shows the profit earned and loss sustained by a business over a particular period (usually 12 months). It shows all revenues earned and expenses incurred during the specified period.

Show question

Question

What is the final feature of the income statement?


Show answer

Answer

Net profit

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Question

What is the net profit?


Show answer

Answer

Net profit is the profit made by a business after all of its expenses have been subtracted from revenues.


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Question

What is the balance sheet?


Show answer

Answer

The balance sheet shows the assets and liabilities of a business at a specific point in time (usually the end of the financial period). It consists of assets, liabilities, and equity.

Show question

Question

Give an example of an asset.


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Answer

For example: 

  • factories, 
  • machinery, 
  • patents, 
  • vehicles,
  • softwares.


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What is a liability?


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Answer

A liability is everything that a company owes.

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What is the final feature of the balance sheet?


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Total equity

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What is the total equity?


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Total equity is a business's capital that belongs to shareholders. This is the money remaining after the business has subtracted liabilities from its assets.


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Give an example of a way to interpret and analyse financial statements.


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Answer

Any of:

  • comparing with previous years, 
  • comparing with competitors, 
  • calculating financial ratios.

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Question

What are the financial ratios?


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Answer

Financial ratios compare the relationship between two or more elements of financial data sourced from a business's financial statements.


Show question

Question

The income statement reveals a company's revenue, expenses, and profits...

Show answer

Answer

during a certain period of time. 

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Question

___ refers to the income the business makes by selling goods or services. The income statement shows the revenue made over a certain period.

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Answer

Revenue

Show question

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