Financial statement
Financial statements are formal records that provide a structured representation of an entity's financial position, financial performance, and cash flows, serving as essential tools for stakeholders to evaluate economic activities and decision-making.[1] These documents are prepared by businesses, non-profits, and governments to summarize transactions and events over a specific period or at a point in time, adhering to established accounting standards to ensure consistency, transparency, and comparability.[2] The core components of financial statements typically include four primary reports: the balance sheet, which details an entity's assets, liabilities, and equity as of a specific date, reflecting its financial condition at that moment; the income statement (also known as the profit and loss statement), which summarizes revenues, expenses, gains, and losses to show net income or loss over a reporting period; the statement of cash flows, which tracks the generation and use of cash from operating, investing, and financing activities; and the statement of changes in equity, which explains variations in shareholders' ownership interests, including dividends, stock issuances, and retained earnings.[2] Accompanying these are extensive notes that provide additional context, accounting policies, and disclosures to aid interpretation.[3] In the United States, financial statements must comply with Generally Accepted Accounting Principles (GAAP), a comprehensive framework developed and maintained by the Financial Accounting Standards Board (FASB) to promote high-quality, relevant financial reporting for public and private entities.[4] Globally, many jurisdictions adopt International Financial Reporting Standards (IFRS) issued by the International Accounting Standards Board (IASB), which emphasize fair presentation and convergence with GAAP to facilitate cross-border comparisons. These standards require audited statements for publicly traded companies, ensuring reliability through independent verification, while also mandating disclosures about risks, uncertainties, and significant events.[2]Fundamentals
Definition and Objectives
Financial statements are formal records that summarize an entity's financial position, performance, and cash flows over a specific period, encompassing key elements such as assets, liabilities, equity, revenues, expenses, gains, losses, investments by owners, distributions to owners, and comprehensive income. These statements are prepared in accordance with standardized accounting principles to ensure consistency and reliability in reporting financial activities.[5][3] The primary objectives of financial statements are to provide relevant and reliable information that assists existing and potential investors, lenders, creditors, regulators, and other users in making informed economic decisions, such as allocating resources or assessing stewardship of management. By presenting data on an entity's economic resources, claims against those resources, and changes therein, financial statements promote transparency, enable comparability across entities and periods, and enhance accountability in financial reporting.[6] A foundational principle in their preparation is the accrual basis of accounting, which recognizes economic events regardless of when cash transactions occur, contrasting with the cash basis that records only actual cash inflows and outflows. This accrual approach better reflects the entity's financial performance and position by matching revenues with related expenses in the appropriate period, except for the statement of cash flows, which uses the cash basis.[7][8] For public companies in the United States, financial statements are typically prepared and filed quarterly via Form 10-Q and annually via Form 10-K with the Securities and Exchange Commission to meet regulatory requirements.[9]Historical Development
The foundations of modern financial statements trace back to the late 15th century, when Italian mathematician and Franciscan friar Luca Pacioli documented the double-entry bookkeeping system in his 1494 treatise Summa de arithmetica, geometria, proportioni et proportionalita. This method, which records each transaction with equal debits and credits to maintain balanced accounts, provided the systematic basis for tracking assets, liabilities, and equity, enabling the preparation of rudimentary balance sheets and income summaries for merchants in Renaissance Venice.[10] The rise of joint-stock companies in the 19th century, particularly in Britain and the United States, marked a pivotal shift toward mandatory financial disclosures to protect investors in these large-scale enterprises. As companies like railroads and manufacturing firms grew, legislation such as the UK's Joint Stock Companies Act of 1844 required basic balance sheets and profit statements to be filed publicly, addressing fraud risks in an era of limited liability and dispersed ownership. This era established financial statements as tools for transparency, influencing similar requirements in other industrializing nations.[11] The Great Depression prompted significant regulatory advancements in the United States, with the Securities Act of 1933 and the Securities Exchange Act of 1934 creating the Securities and Exchange Commission (SEC) to oversee financial reporting. These acts mandated audited financial statements, including balance sheets and income statements, for public companies to ensure full disclosure of material information, fundamentally shaping standardized corporate reporting worldwide. Post-World War II economic globalization further internationalized these practices, as multinational trade demanded comparable financial data across borders.[12] Throughout the 20th century, financial reporting evolved from cash-based accounting—focusing on actual inflows and outflows—to accrual accounting, which recognizes revenues and expenses when earned or incurred, providing a more accurate picture of economic performance. This transition gained momentum in the mid-1900s through U.S. Generally Accepted Accounting Principles (GAAP), formalized by bodies like the Accounting Principles Board, and reflected broader needs for reliable long-term financial analysis. In 1973, the Financial Accounting Standards Board (FASB) was established as an independent standard-setter to codify GAAP, enhancing consistency in statement preparation.[4] The push for global harmonization culminated in 2001 with the formation of the International Accounting Standards Board (IASB), succeeding the International Accounting Standards Committee to develop International Financial Reporting Standards (IFRS) for uniform reporting. Recent developments have integrated technology and expanded scope: the SEC mandated XBRL (eXtensible Business Reporting Language) for U.S. public filers starting in 2009, enabling interactive, machine-readable financial statements to improve data accessibility and analysis. Post-2020, emphasis on sustainability has grown, with the International Sustainability Standards Board (ISSB) issuing IFRS S1 and S2 in 2023 to require disclosures of sustainability-related risks and opportunities affecting financial performance.[13][14][15] By 2025, more than 30 jurisdictions had adopted or were implementing the ISSB standards, with ongoing amendments to greenhouse gas emissions disclosures and the ISSB advancing requirements for nature-related risks and opportunities following collaboration with the Taskforce on Nature-related Financial Disclosures (TNFD) in November 2025.[16][17] In the United States, the SEC adopted climate-related disclosure rules in 2024 but ended their defense in March 2025 amid legal challenges, stalling mandatory sustainability reporting under federal regulations.[18]Core Financial Statements
Balance Sheet
The balance sheet, also referred to as the statement of financial position under International Financial Reporting Standards (IFRS), presents a snapshot of an entity's financial position at a specific reporting date by detailing its assets, liabilities, and equity.[3] This statement is structured around the fundamental accounting equation, Assets = Liabilities + Equity, which ensures that the total value of resources controlled by the entity equals the claims against those resources by creditors and owners.[19] The equation reflects the double-entry bookkeeping system, where every transaction affects at least two accounts to maintain balance.[20] Assets and liabilities on the balance sheet are generally classified as current or non-current to provide insight into the entity's short-term and long-term financial dynamics. Current assets include items expected to be converted to cash, sold, or consumed within one year or the normal operating cycle, whichever is longer, such as cash and cash equivalents, accounts receivable, and inventory.[19] Non-current assets encompass longer-term resources like property, plant, and equipment (PPE), intangible assets, and long-term investments. Current liabilities cover obligations due within one year, including accounts payable and short-term debt, while non-current liabilities include long-term debt and deferred tax liabilities. Equity represents the residual interest in assets after deducting liabilities, comprising components such as common stock (representing contributed capital) and retained earnings (accumulated net income less dividends).[19] In preparing the balance sheet, entities apply specific valuation methods to ensure reliable reporting of asset and liability values. The primary basis is historical cost, which records assets and liabilities at their original acquisition or incurrence amount, adjusted for amortization or depreciation where applicable. Fair value measurement is used for certain items, such as financial instruments or investment properties, defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. Under U.S. Generally Accepted Accounting Principles (GAAP), similar principles apply, with historical cost as the default and fair value required for items like trading securities.[21] These methods promote consistency and relevance, though entities must disclose the measurement basis for each class of assets and liabilities.[19] A simplified balance sheet format illustrates these elements, typically presented with assets on one side (or top) and liabilities plus equity on the other (or bottom), ensuring the totals balance. The following example for a hypothetical manufacturing company as of December 31, 2025, uses historical cost for PPE and fair value for certain investments (in thousands of USD):| Assets | Amount | Liabilities and Equity | Amount |
|---|---|---|---|
| Current Assets | Current Liabilities | ||
| Cash and equivalents | 150 | Accounts payable | 80 |
| Accounts receivable | 200 | Short-term debt | 50 |
| Inventory | 300 | Total Current Liabilities | 130 |
| Total Current Assets | 650 | ||
| Non-Current Assets | Non-Current Liabilities | ||
| Property, plant, and equipment (net) | 800 | Long-term debt | 400 |
| Investments (at fair value) | 100 | Total Non-Current Liabilities | 400 |
| Total Non-Current Assets | 900 | Equity | |
| Total Assets | 1,550 | Common stock | 500 |
| Retained earnings | 520 | ||
| Total Equity | 1,020 | ||
| Total Liabilities and Equity | 1,550 |
Income Statement
The income statement, also referred to as the profit and loss statement or statement of comprehensive income, reports a company's financial performance by detailing revenues earned, expenses incurred, and the resulting net income or loss over a specific reporting period, typically a quarter or fiscal year.[3][24] Under international financial reporting standards (IFRS), it is presented as the "statement of profit or loss and other comprehensive income," while under U.S. generally accepted accounting principles (GAAP), it focuses on the statement of operations leading to net income.[3][24] This statement is essential for assessing operational efficiency, as it highlights how effectively a company generates profit from its core activities before considering financing and investing decisions.[25] In April 2024, the International Accounting Standards Board (IASB) issued IFRS 18 Presentation and Disclosure in Financial Statements, which replaces IAS 1 and introduces enhanced requirements for the statement of profit or loss, effective for annual reporting periods beginning on or after 1 January 2027 (with early application permitted). Key changes include mandatory subtotals for operating profit (reflecting results from the entity's main business activities) and profit before financing and income taxes, along with new principles for classifying income and expenses into operating, investing, financing, income taxes, and discontinued operations categories to improve comparability. These updates aim to provide more consistent and transparent reporting of financial performance without altering the overall structure of other core statements.[26] The fundamental structure of the income statement follows the equation: revenues minus expenses equals net income, providing a clear progression from top-line sales to bottom-line profitability.[27] Two primary formats exist: the single-step format, which simply aggregates all revenues and gains against all expenses and losses to arrive at net income in one calculation, and the multi-step format, which uses intermediate subtotals to classify items into operating and non-operating categories for greater detail.[28][29] The multi-step approach is more common for manufacturing and merchandising firms, as it separates cost of goods sold (COGS) from operating expenses to reveal gross profit and operating income.[29] Key components include revenues, primarily from sales of goods or services, supplemented by other income such as interest or rental earnings; expenses, encompassing COGS (direct production costs like materials and labor), operating expenses (indirect costs like selling, general, and administrative or SG&A), interest, and taxes; and other comprehensive income, which captures unrealized gains or losses on items like foreign currency translations or certain investments not included in net income.[3][24][27] Preparation adheres to accrual accounting principles, recognizing revenues when earned and expenses when incurred, rather than when cash is exchanged, to ensure a faithful representation of economic events.[25] Central to this is the matching principle, which pairs expenses with the revenues they help generate in the same period, promoting accurate measurement of profitability.[25][30] Common subtotals derived during preparation include gross profit, calculated as: \text{Gross Profit} = \text{Revenue} - \text{COGS} which indicates production efficiency; operating income, or EBIT (earnings before interest and taxes), computed as gross profit minus operating expenses, reflecting core business performance; and EBITDA (earnings before interest, taxes, depreciation, and amortization), a non-GAAP metric often used to evaluate operational cash flow potential, defined as: \text{EBITDA} = \text{Operating Income} + \text{Depreciation} + \text{Amortization} .[27][31] These measures help stakeholders gauge earnings quality and sustainability without distortion from non-cash or financing items.[31] The income statement's net income figure ultimately flows into retained earnings on the balance sheet, influencing equity.[27] By focusing on performance over time, it enables comparisons of profitability trends and supports decisions on resource allocation and investment.[24]Cash Flow Statement
The cash flow statement reports the inflows and outflows of cash and cash equivalents during a reporting period, providing a basis for assessing an entity's ability to generate cash and its needs to utilize those funds.[32][33] It classifies cash flows into three primary categories: operating activities, which reflect cash generated from core business operations; investing activities, which include cash flows from the purchase or sale of long-term assets and investments; and financing activities, which encompass cash flows related to debt issuance or repayment and equity transactions such as dividends or stock repurchases.[34][35] Under both IFRS (IAS 7) and US GAAP (ASC 230), entities may present operating cash flows using either the direct method, which reports major classes of gross cash receipts and payments, or the indirect method, which starts with net income and adjusts for non-cash items, deferrals, accruals, and changes in working capital.[34][35] The direct method is encouraged under IAS 7 for its detailed insight into cash receipts from customers and payments to suppliers, though the indirect method is more commonly used due to its alignment with the income statement and simpler preparation.[34][36] For the indirect method, operating cash flow is typically calculated as net income plus non-cash expenses like depreciation and amortization, minus increases in working capital or plus decreases, ensuring reconciliation between accrual-based net income and actual cash generated from operations.[35][37] Preparation of the cash flow statement involves reconciling the beginning and ending balances of cash and cash equivalents as reported on the balance sheet, with the net change explained by the sum of cash flows from operating, investing, and financing activities.[34][35] This reconciliation highlights how changes in balance sheet accounts, such as accounts receivable or inventory, impact cash flows, providing a link between the cash flow statement and the balance sheet.[37] Non-cash transactions, like issuing stock for assets, are excluded but disclosed separately to maintain focus on actual cash movements.[34] The cash flow statement is significant for revealing an entity's liquidity position and effectiveness in managing cash resources, complementing accrual-based statements by focusing on actual cash generation and usage rather than timing differences in recognition.[37] It became mandatory under US GAAP with FASB Statement No. 95 in 1987 (effective 1988) and under IFRS with IAS 7 in 1992, primarily to address the limitations of accrual accounting by providing transparent information on cash flows essential for assessing solvency and financial flexibility.[34]Statement of Changes in Equity
The statement of changes in equity is a financial statement that reconciles the beginning and ending balances of shareholders' equity for a reporting period, providing a detailed breakdown of all transactions and events that affect equity components. It serves as a key component of the complete set of financial statements under International Financial Reporting Standards (IFRS), where it is required as one of the primary statements per IAS 1, Presentation of Financial Statements, which was amended in 2007 to mandate its separate presentation. Under U.S. Generally Accepted Accounting Principles (U.S. GAAP), as outlined in ASC 505-10-50-2, disclosure of changes in each equity account is required when a balance sheet and income statement are presented, though it may appear as a separate statement or in the notes, making it optional but commonly provided for transparency. This statement highlights how net profits are either retained for reinvestment or distributed to owners, offering insights into the company's capital management and financial health. The structure of the statement typically features columns for major equity components, such as share capital (or common stock), retained earnings, other reserves (including accumulated other comprehensive income), and total equity attributable to owners of the parent. Rows detail the specific changes, starting with the opening balance (carried forward from the prior period's balance sheet), followed by additions like net income from the income statement and issuances of new shares, then deductions such as dividends declared and any net losses, and finally other comprehensive income items like unrealized gains or losses on available-for-sale securities or foreign currency translation adjustments. For entities with non-controlling interests, an additional column reconciles those amounts separately. Under IFRS, IAS 1 paragraph 106 requires the statement to show the total comprehensive income for the period, effects of any retrospective applications or restatements, a reconciliation for each equity component, and dividends recognized as distributions to owners. U.S. GAAP similarly emphasizes these elements but allows flexibility in format as long as changes are fully disclosed per ASC 505.[3][38] Key components include additions such as net income, which transfers profit from the income statement to retained earnings, and proceeds from new share issuances that increase share capital; deductions encompass dividends paid to shareholders, reducing retained earnings, and any reported losses that diminish equity. Other comprehensive income captures items not included in net profit, such as revaluation surpluses or actuarial gains/losses on defined benefit plans, which are routed through reserves rather than the income statement. These elements ensure a comprehensive view of equity movements, excluding direct cash flow details but linking indirectly through the impacts of income and distributions. The statement's preparation begins with the opening equity balances from the prior balance sheet, incorporates net income or loss directly from the income statement, adjusts for other comprehensive income as defined under IAS 1 or ASC 220, accounts for owner transactions like share repurchases or issuances per ASC 505-30, and concludes with closing balances that must reconcile to the current period's balance sheet equity section.[19][38][39] To illustrate, a simplified example of the statement's reconciliation table might appear as follows, assuming a basic corporate structure:| Share Capital | Retained Earnings | Other Reserves | Total Equity | |
|---|---|---|---|---|
| Balance at beginning of period | $100,000 | $200,000 | $50,000 | $350,000 |
| Net income for the period | - | $80,000 | - | $80,000 |
| Other comprehensive income (e.g., unrealized gains) | - | - | $20,000 | $20,000 |
| Issuance of new shares | $50,000 | - | - | $50,000 |
| Dividends paid | - | ($30,000) | - | ($30,000) |
| Balance at end of period | $150,000 | $250,000 | $70,000 | $470,000 |