The world of finance is surrounded by a sea of paperwork—a sea that’s easy to get lost in if you don’t yet understand financial statements. Fortunately, studying up on the most frequently used financial statements can lift the fog off this proverbial sea, making it much more straightforward to navigate financial analysis.
This article is meant to demystify and clarify what these financial statements are all about. We’ll break down:
- Which statements are important to analyze
- What data are found in these documents
- What insights you can pull from each statement
- Which technology is best used to manage data sets from these statements
What are financial statements?
Financial statements are written documents that outline the business activities of a company. These statements are analyzed to infer the financial performance and well-being of a business, helping make future projections and decisions based on historical trends.
The 4 types of financial statements
You can’t decipher financial well-being from a single financial statement—you need different perspectives to paint a clear picture. There are four primary types of financial statements:
- Balance sheets
- Income statements
- Cash flow statements
- Statements of shareholders’ equity
But before we dive in, know that all financial statements are inward-looking and historical. They don’t come with built-in insights and suggestions for what to do about the data. Rather, it’s up to you to deliver a future-forward strategy based on your findings. That’s where a function like comes into play, helping your business analyze and execute forecasts and trends.
Each statement provides a unique lens and set of data with enriching insights to transform your overall strategy.
1. Balance sheet
The balance sheet is an item-by-item breakdown of everything the company owns, including assets, liabilities, shareholder equity, and other variables during a specific moment in time. Balance sheets also communicate exactly how much a company is worth, totaling the value of these variables into a single monetary total.
The following is a breakdown of a balance sheet’s format:
- Assets: What does the company own? Buildings, inventory, cash—everything is listed as an item on the balance sheet. These can be further broken down into current assets (cash, inventory, accounts receivable) and non-current/fixed assets (property, equipment, patents, licenses)
- Liabilities: What does the company owe? Long-term debts, accrued expenses, deferred revenue—every outstanding expense the company still has to pay is listed in this section. The cost of every liability is also totaled up to reflect a single price point
- Equity: What is owed to the owners of the company? Whatever money is left after liabilities are accounted for goes to the owners of the business. This is broken down into categories similar to those in the statement of shareholders’ equity, such as common stock and preferred stock
A company’s balance sheet and other financial statements can be analyzed from multiple points of view.
Internal balance sheet insights
The internal view encompasses the needs and perspectives of business leaders, employees, shareholders, and other internal players. Invested parties use the balance sheet to get a snapshot view of whether the company is succeeding or failing. Depending on their findings, the internal players may make policy or financial changes to remedy shortcomings or bolster successes.
External balance sheet insights
The external view of a balance sheet is typically for potential investors and regulators who may have specific requirements for what information to share and how to present it. For those interested in purchasing shares, the balance sheet offers insight into what resources are available to the business and how those resources are financed. Based on their findings (along with any additional insights gleaned from the risk report), potential investors will determine if the company is worth investing in.
You cannot gather these insights from a single document. Comparing your current balance sheet to previous periods will reveal potential trends that can be compared and assessed.
2. Income statement
Sometimes referred to as a profit and loss statement, income statements describe what the company did with the money it earned and spent. This essentially reveals its activities between balance sheets. Income statements include all revenues, expenses, gains, and losses that occurred during a period. This is often broken down into the following categories:
- Revenue: How much money a business earns during the recorded period
- Costs of goods sold (COGS): The cost behind what it takes to make the units sold
- Gross profit: Total revenue minus COGS
- Expenses: How much money the company spent during the recorded period
- Operating income: Total profits minus any operating expenses, such as labor
- EBITDA: Earnings before interest, depreciation, taxes, and amortization
- Depreciation: How much value its assets have lost over time
- Income before taxes: Income minus costs but before the exclusion of applicable taxes
- Net income: Total income after all costs are subtracted
- Earnings per share: Income divided by the total number of outstanding shares
Income statements paint a picture of a company’s financial performance. Therefore, potential investors gain further insight into the company’s profitability. Additionally, investors can compare income statements against projected earnings to determine whether or not a company is on the right track.
3. Cash flow statement
Cash flow statements show how the company uses its revenue. These give investors and shareholders a direct look into how effectively the company is spending its money, particularly in the context of long-term and short-term investments.
A cash flow statement is broken down into three categories:
- Financing activities: Cash flow from debt or equity financing
- Investing activities: Cash flow from purchasing or selling assets using free cash, which may include real estate investments, vehicles, or the purchase of non-physical assets such as patents and licenses
- Operating activities: Cash flow that encompasses regular goods and services, including both the associated revenue and expenses
Direct vs indirect cash flow
Cash flow statements cover two forms of cash flow methods: direct and indirect. The direct cash flow method is a simplified approach to seeing how cash flows in and out of your business. Cash flow statements using this method will attribute cash movement to actual items, like salaries, vendor payments, or interest payments.
An indirect cash flow method starts with your net income and works backward. Using that net income as a base, a company would add non-cash expenses (like depreciation), non-cash incomes, and any net adjustments between current assets and liabilities. Direct cash flow ignores depreciation and other non-cash factors.
The purpose of cash flow statements
Cash flow statements, like all other financial statements, offer a clear perspective for investors. If the cash flow analysis observes a healthy, consistent cash flow, that is going to inspire more investors than one that is uneven or unsustainable. Internally, a department head might observe irregularities or inefficiencies in the cash flow, which may inspire restructuring or an adjustment of the company’s activities.
4. Statements of shareholders’ equity
The statement of shareholders’ (or stockholders’) equity outlines the changes in ownership interests for the company’s shareholders.
The statement of changes in equity is a relatively straightforward calculation: Simply find the difference between a company’s total assets and total liabilities. However, this financial statement goes deeper than the calculation alone. The statement of shareholders’ equity includes a few key components:
- Common stock: A type of ownership stake in the company that comes with voting rights on corporate decisions—common stockholders have the lowest priority claim on a company’s assets
- Preferred stock: A special ownership stake that offers stockholders a higher claim to a company’s assets and earnings than common stockholders—companies report preferred stocks at face value in the statement of shareholder’s equity
- Retained earnings: The total earnings of a company after it distributes dividends to its shareholders
- Treasury stock: Stocks that the company repurchased. This is often done to avoid hostile takeovers or to temporarily boost stock prices. However, shareholder equity is reduced by the amount of money spent to repurchase these stocks
- Unrealized gains and losses: The changes in pricing for investments that have not yet been cashed in. Unrealized gains occur when the investment increases in value but hasn’t been cashed in, while unrealized losses occur with a decrease in investment value
- Additional paid-up capital: The excess amount investors pay over the face value (aka par value) of the company’s stock
The statement of shareholders’ equity report is created with investors in mind, as it gives them important information and context into why their equity increases or decreases. It also alerts them to what is and isn’t working in the financials of the company, which may influence future investment decisions.
When should you create these financial statements?
Most financial statements are created on a monthly, quarterly, or annual basis. It largely depends on the goals of the company or the shareholders.
Some companies may not create a separate document for each type of financial statement. For example, some may opt to include the statement of shareholders’ equity in the balance sheet.
Going beyond financial statements
Financial statements clarify to investors how much money the company is making. But today’s investors want to know more, like what financial risks the business is facing. Because of this, external financial reports, especially if you have public shareholders, frequently include risk reports or a discussion of risk factors.
Common types of risk include:
- Organizational risks: Is the company’s structure appropriate for the business? Are there gaps in upper management that need to be addressed?
- Liquidity risks: Can the company easily convert assets to cash if needed? Are there seasonal downturns that can affect the long-term profitability of the company?
- Market risks: What shifts in the market could affect your entire industry? How are other companies in the marketplace faring in the current economic climate? Have current events disproportionately affected the market’s ability to deliver?
- Operational risks: What threats are there to an organization’s workforce, processes, or systems? Does the company have sound insurance policies and controls in place? Is there a significant risk of lawsuits, fraud, or personnel issues?
Whatever the case, these insights provide investors with information to help determine whether the risks are worth the potential rewards. This often leads to a discussion or negotiation between auditors and internal management to discuss the risks so the company can better defend or explain its position.
ESG risks
As the importance of environmental, social, and governance (ESG) standards has increased in the public eye, ESG has become a significant risk factor. Many companies include risk reports in their financials specifically because of increased ESG scrutiny. Companies are now held to a higher standard of ESG risk assessment by consumers, stockholders, and their markets to adopt ethical and renewable practices.
How technology simplifies reporting of financial statements
When you think of the benefits technology brings to compiling financial statements and to financial statement analysis, you probably think immediately of efficiency and speed. This is true. Finance technology, whether digital spreadsheets or blockchain transactions, has simplified aspects of financial reporting every step of the way.
But efficiency means nothing without accuracy. Above all else, financial statement software helps you maintain confidence in your data as you collaborate with your team. That confidence comes from having control over the data until it enters your final report. And control is best achieved through technology that limits the risk of human error. Here are two common areas where technology can help.
Data collection and consistency
Financial figures are often shared across multiple documents and formats, from spreadsheets to investor reports. You may even see the same data point converted into a percentage or translated into a different currency or language.
The Workiva platform offers linking, which keeps your data consistent across all documents. If you update a data point in one place, linking will update it across every place that data was linked. This gives you the power to reduce the constant need for checking and cross-checking that ultimately undermines the confidence you have in your reports.
XBRL® tagging
Regulators, including the U.S. Securities and Exchange Commission and European Securities and Markets Authority, require companies to add machine-readable XBRL tags to their data. That makes it easier for regulators and institutional investors to consume and analyze your data at scale.
Companies have to tag dozens or even hundreds of data points in their financial statements, which is a highly specialized skill. That’s where Workiva comes in. Our XBRL software enables your teammates to add these tags themselves if you don’t want a vendor to apply tags for you. Our software is also smart enough to flag data that your peers may be tagging differently.
How has artificial intelligence changed financial statement analysis?
Artificial intelligence (AI) has done wonders for speeding up financial analysis and helping companies meet the growing demands of the market and their shareholders. However, its use for financial statement preparation and analysis should be done with human supervision.
In reality, AI is great for helping you gather scattered data and organizing your data sources. But, like humans, AI can easily miss something if it’s not told to look for it. That leaves fringe data or data that wasn’t properly inputted in the dust.
While AI can still be an incredibly powerful tool, it’s most effective if you unleash it on organized data—data sets that are indexable and categorized correctly.
Workiva Generative AI
At Workiva, we have built a generative AI tool into the platform that is meant to augment your work and enhance your expertise. Workiva Generative AI serves as an on-demand assistant that can help you brainstorm, research, write, and reformat. By using Workiva Gen AI, you never have to leave the platform when you hit a bump in productivity—for example, trying to craft a new disclosure with your existing content—ensuring your data remains in a secure environment. Plus, you get results anchored to the work you are doing, whether it’s focused on financial statements, risk assessments, or ESG reports. All analysis is done within our platform, so you don’t have to bounce between dozens of tabs and PDFs or paste potentially sensitive data in a gen AI chatbot in the public domain. You can stay on task and find answers with ease.
There will always be an open sea of data and financial statements to scan through and decipher. But with the right tools, you can build greater confidence and collaboration within your datasets and embark toward your financial goals with conviction.
Try Workiva today! Request a demo to see how the Workiva platform brings clarity and confidence as you pull data and insights from your financial statements.
