Financial Statements

Financial statements are written reports that quantify the financial strength, performance and liquidity of a company. They provide a snapshot of the financial health of an organization and allow investors, creditors, and internal management to evaluate the company.

The four primary financial statements are:

1. Income Statement
2. Balance Sheet
3. Statement of Cash Flows
4. Statement of Changes in Equity

Collectively, these statements provide information about a company's revenues, expenses, assets, liabilities, cash flows, and changes in equity over a stated time period. They follow a set of standardized accounting rules, principles and formats.

For small businesses, freelancers, startups and agencies, maintaining proper financial records and generating these statements is crucial for understanding the financial situation of the enterprise. Let's go through each statement in more detail:

Income Statement
The income statement summarizes a company's revenues and expenses for a period. Its purpose is to show if the company was profitable (revenues exceeded expenses) or not, and by how much.

The income statement calculates:
Revenues - Expenses = Net Income (Profit) or Net Loss

For a freelance web developer, revenues would include amounts earned from client projects. Expenses would include costs like home office, software subscriptions, professional development, etc.

For a small marketing agency, revenues are amounts billed to clients for services rendered. Expenses include employee salaries, rent, utilities, marketing costs, etc.

The income statement answers - Did the company make a profit this period? If so, how much?

Statement of Changes in Equity
This statement shows what happened to the shareholders' equity accounts during the period.

The columns track:
1. Beginning balance in each equity account
2. Any increases (+) or decreases (-) during the period
3. Ending balance

For an introductory course, the two key equity accounts are:
1. Common Shares - The equity investment by owners
2. Retained Earnings - Profits reinvested back into the company

For a startup funded by investor money, the common shares would increase. Retained earnings tracks net income earned and retained versus distributed out as dividends.

For a freelancer operating as a sole proprietorship, there are no common shares. Retained earnings simply tracks the cumulative net income invested back into the business.

Balance Sheet
The balance sheet lists all of a company's assets, liabilities, and shareholders' equity as of a specific date.

The fundamental accounting equation is:
Assets = Liabilities + Shareholders' Equity

Assets are economic resources owned, such as:
- Cash
- Accounts Receivable (amounts owed by customers)
- Inventory
- Equipment
- Vehicles
- Property

Liabilities are obligations or debts owed, such as:
- Accounts Payable (amounts owed to vendors)
- Notes Payable (loans)
- Mortgages
- Accrued Expenses (unpaid utilities, taxes, etc.)

By subtracting liabilities from assets, we can calculate the residual shareholders'/owners' equity.

For a freelance graphic designer, assets may include cash, accounts receivable from clients, computers and equipment. Liabilities could include unpaid expenses or a loan.

The balance sheet shows what the company owns (assets) and owes (liabilities and equity) as of that date. This allows analysis of the financial position.

Preparing and understanding them is fundamental to accounting for any business.