Financial Statements 101 - The Big Three

Let's get back to basics here and review the big three financial statements you are going to run into in business and personal investing; the balance sheet, the income statement and the cash flow statement.

The Balance Sheet

Simply put the balance sheet is Assets = Liabilites + Equity. Assets include everything you "have", such as cash, inventory and buildings, liabilities include everything you "owe" such as a credit line with the bank for the inventory and a long term note against the building, and equity is the "value to the owners" or let's say for example's sake, the difference between what your building is worth and how much you owe. So, if your building is worth $100,000 and you owe the bank $50,000, then your equity is $50,000. This would be represented on the balance sheet like so:

Of course, this is a rather simplistic picture for even this balance sheet item. You would have other considerations such as accumulated depreciation (how much decline in useful value of the fixed asset have you recorded) as well as the current portion of the long term note (how much is due in total over the next year) but let us stick with the basics for now.

The balance sheet is a snapshot in time of what the company has, owes and is worth. Building on this analogy, the balance sheet is what the company has today (assets), what it owes today (liabilities) and what it is worth today (shareholders' equity.) Digging into the balance sheet, let us look at the first category ...

Assets

Assets are everything you've got, including cash in the bank, inventories, buildings, machinery, etc. as well as certain rights you have with a monetary value. Specifically, this would include your accounts receivable, what your customers owe you. Assets on the balance sheet are ordered from most liquid (current assets) to least liquid (fixed assets.) Current assets generally include the categories of cash, accounts receivable, inventory and prepaid expenses and fixed assets include items such as building and equipment.

Here's what the asset side of the balance sheet looks like with these items. Note the additional categories of other assets and accumulated depreciation. Sample data has been inputted as well so you can follow the math of the line items.

Now, let's turn to the flip side of the balance sheet and take a look at liabilities.

Liabilities

Mirroring the Asset side of our balance sheet, the liability side is going to list liabities from current to long-term. The categories you see here will include current liabilites, which includes accounts payable, accrued expenses, the current portion of debt and income taxes payable as well as long term debt. Here is what the liability portion of the balance sheet is typically going to look like:

Those current liabities are bills that must be paid within one year of the date of the Balance Sheet. Accrued expenses are monetary obiligations similiar to accounts payable (bills to other companies for material and equipment bought on credit). Examples would include employee salaries earned but not paid yet, interest due but not paid yet, etc. Current portion of the debt includes any notes payable (loans due in 12 months) and the payment portion of long term debt that is due in 12 months. Income taxes payable are just what it says - income taxes that are owed but have not been paid yet. Long-term debt is any loan to the company that has to be repaid more than 12 months afte the date of the Balance Sheet.

Let's move to the equity portion of the balance sheet or as properly termed, Shareholder's Equity.

Equity

The net-net to this section of the balance sheet is that if you subtract what you owe from the assets you get the owner's value in the company or equity.

Here is what this portion of the balance sheet looks like:

Capital stock is the original amount of money the owners contributed as their investment in the stock of the company. Retained earnings is all the earnings of the company that have been retained - not paid out as dividends to owners. Retained earnings can be viewed as a "pool" of money from which future dividends could be paid.

So, here's the complete picture, remember it must balance - Assets = Liabilities + Equity:

Next, the income statement.