What is a Balance Sheet?
The balance sheet is another name for the statement of financial position. It is one of the main financial statements. The balance sheet presents a company’s financial position at the end of a specified date. Some describe this as a “snapshot” of the company’s financial position at a point (a moment or an instant) in time. For example, the amounts reported on a balance sheet dated December 31, 2019 reflect that instant when all the transactions through December 31 have been recorded.
Because the balance sheet informs the reader of a company’s financial position as of one moment in time, it allows someone, like a creditors, to see what a company owns as well as what it owes to other parties as of the date indicated in the heading. People who would be interested in the balance sheet include bankers, current investors, potential investors, company management, suppliers, some customers, and competitors.
What is a Profit and Loss statement?
A profit and loss statement (P&L), or income statement, is a financial report that provides a summary of the company’s revenues, expenses and profits/losses over a given period of time. The P&L statement shows a company’s ability to generate sales, manage expenses and create profits. It is prepared based on accounting principles that include revenue recognition, matching and accruals, which makes it different from the cash flow statement.
Structure of the Profit and Loss Statement
A company’s statement of profit and loss is portrayed over a period of time, typically a month, quarter, or fiscal year.
The main categories that can be found on the P&L include:
- Revenue (or Sales)
- Cost of Goods Sold (or Cost of Sales)
- Selling, General & Administrative Expenses
- Marketing and Advertising
- Interest Expense
What is a Cash Flow Statement?
The cash flow statement reports the cash generated and used during the time interval specified in its heading. Generally, the period of time is the same as the profit and loss statement.
Because the profit and loss statement is prepared under the accrual basis of accounting, the revenues reported may not have been collected or turned into cash. Similarly, the expenses reported on the profit and loss statement might not have been paid. A person could review the balance sheet changes to determine the facts, but the cash flow statement already has integrated all that information. As a result, savvy business people and investors recognise the cash flow statement as an important financial statement.
Here are a few ways the cash flow statement is used.
- The net cash from operating activities is compared to the company’s net income. (“Net cash” is the cash inflows minus the cash outflows.) If the net cash from operating activities is consistently greater than the net income, the company’s net income or earnings are said to be of a “high quality”. If the net cash from operating activities is less than net income, a red flag is raised as to why the reported net income is not turning into cash.
- Some investors believe that “cash is king”. The cash flow statement identifies the cash that is flowing in and out of the company. If a company is consistently generating more cash than it is using, the company will be able to expand its operations, replace inefficient equipment, increase its dividend, buy back some of its stock, reduce its debt, or acquire another company. All of these are perceived to be good for stockholder value.
Some financial models are based upon cash flow.
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