Financial statements are a vital tool for businesses and investors alike. They’re used to illustrate the financial health and performance of your company — but exactly what do financial statements contain? And how do they differ from one another? When looking at financial statements, you need to understand the Elements of Financial Statements. Having a basic understanding of financial statements will help you give better feedback when reviewing other people’s financial reports. Here are five elements that should be included in your financial statements:
- Assets,
- Liabilities,
- Equities,
- Revenues, and
- Expenses
This guide will explain what each element means and how you can use them for your own business.
The Financial Statements
The income statement is the most important section of your financial statements, because it tells you how much money your business makes. The balance sheet shows how much is being held in cash, debts and investments. The statement of cash flow shows where all that money came from and where it went.
What Does The Elements of Financial Statements Signify?
The elements of financial statements are:
- Assets, liabilities and equity: These three items are the most important in accounting because they determine how your business makes money.
- Income, expenses and gains: These elements tell you how much money (or loss) your company earned during a period of time—and also how much it spent during that same period of time.
Assets
Assets are the things that have value, but are not cash – these are the things your company owns, such as cash, buildings and equipment. For example, you might have an asset that is intangible (such as goodwill from a business merger) or tangible (such as a building).
Tangible assets include:
- Buildings and equipment;
- Inventory and Cash
Intangible assets include:
- Brand Value
- Trademarks & Intellectual properties
Liabilities
Liabilities are the financial obligations of a business that must be paid in the future. These are things that your company owes, such as loans and credit card debt. For example, if you borrow money to buy equipment for your business and then don’t pay it back in time, you have a liability.
Liabilities include:
- Loans payable
- Accounts payable
- Taxes payable
- Accrued expenses
For an instance, let’s consider accounts payable – This is the money owed to suppliers, landlords and other creditors for goods or services received by your business during a specific period, i.e., if you purchase equipment from a supplier and pay them at the time of purchase; this would be an account payable item on your balance sheet. The amount owed will decrease each month as payments are made against it (i.e., unpaid balances). A liability for accounts payable may also include any interest-bearing loans due within one year from when they were granted/borrowed by yourself/your company etc., depending upon whether these items are convertible into cash or not.
Equity
Equity is the difference between assets and liabilities. The net worth of a business is its equity, which is equal to its assets minus liabilities. The owner’s investment in a business can be measured as equity, which will vary depending on their level of ownership (i.e., they may have put up capital or just paid for shares).
The level of ownership can also affect how much you pay for your shareholding in an organization. When you have a large equity stake in a company, there is less of a risk to the owners because they are not putting up all of their assets. This means that they will expect to be paid more for their investment than someone who has a smaller shareholding.
Revenue (Income)
Revenue is the money that comes into a business. It can be earned in one of three ways:
- Selling products or services.
- Providing services.
- Buying assets like land, buildings and equipment.
Revenue is clearly an important part of your business’s financial statements, but how do you know how much income you’ve got? The answer lies in your profit and loss account. This is a record of all the money that comes into and goes out of your business, broken down into categories like sales revenue, expenses and taxes. By looking at these figures, you can see exactly how much income you’ve got, where it came from and how much tax you paid on it.
Expenses (Costs)
Expenses (costs) are the opposite of revenue. They are costs that a company incurs in order to make money, or spend money on in order to get more profit.
In accounting terms, expenses are those outflows of cash from the business. Expenses can be divided into two categories: direct and indirect. Direct expenses are the costs of goods sold, which include the price that you paid for materials to make your product plus any other costs associated with making it. Indirect expenses are those that don’t directly relate to making a product but do have a financial impact on your business as a whole, such as rent and utilities.
Why SMEs need to understand the Elements of Financial Statements
The Elements of Financial Statements is a key tool for business owners. It helps you make decisions about your business and allows you to measure its performance, compare it with other similar businesses in your industry, and plan for the future. Financial statements are the heart of business accounting. They don’t tell you what to do with your business, but they provide you with the information you need to make good decisions about its future.
The Elements of Financial Statements shows you:
- How your business is performing, including its profitability and how much cash it has on hand at any given time
- How much debt you owe to creditors, including loans from banks or other financial institutions
Conclusion
The Elements of Financial Statements are essential for small businesses, and they’re easy to understand. The financial statements you create will help you manage your company and make informed decisions about the future.
Financial statements are the lifeblood of your business. They tell you how much money your company has, how much it owes and what its future looks like. If you don’t understand how to read them, they can be confusing and hard to interpret.
With the financial statements in hand, and an understanding of all the financial elements, you can make good decisions about your business. You’ll know how well (or not) it is doing and whether or not it needs new resources to stay afloat.