Financial Glossary
Financial statements
Financial statements are the formal, standardized output of the accounting process, comprising three primary documents: the income statement (revenues, expenses, and net income over a period), the balance sheet (assets, liabilities, and equity at a point in time), and the statement of cash flows (operating, investing, and financing cash movements over a period). Together they present a comprehensive picture of financial performance and position. A fourth statement, the statement of changes in equity, reconciles beginning and ending equity. For businesses required to follow GAAP or IFRS, financial statements must include disclosures in the footnotes that explain accounting policies, significant estimates, and contingent liabilities.
Problem & Application
A campground operator applying for a $2 million SBA loan submits two years of financial statements. The lender's underwriter reviews the income statement to confirm consistent revenue and operating profitability, checks the balance sheet to verify that equity is positive and that current assets exceed current liabilities, and studies the cash flow statement to confirm that operating activities generate positive cash flow each year -- because a business can show paper profit while consuming cash. In this case, the operating cash flow is lower than net income because the operator carries large seasonal receivables. The underwriter uses the cash flow statement to determine the operator's true debt service coverage, which is the ratio used to determine whether the business generates enough cash to service the new loan.
In Short
Financial statements are essential for understanding a company’s financial health and ensuring transparency with stakeholders.