The four basic financial statements every business needs are the income statement, balance sheet, cash flow statement, and statement of retained earnings. Taken together, these four financial statements provide an accurate representation of the company’s overall financial status.

Understanding the main four types of financial statements is crucial for investors, analysts, and other stakeholders seeking insights into a company’s financial well-being and future prospects. Furthermore, as a business owner or finance officer, you might be interested in using them to assess the performance of different facets of your operations to identify areas of strength and opportunities for improvement.

Income Statement: Unveiling Profitability

The income statement, often referred to as a profit and loss (P&L) statement, shows a company’s financial performance over a specific period, such as monthly, quarterly, or annually. This financial document is the first port of call for stakeholders like investors and business owners because it encapsulates the essence of the business’s operational outcomes.

As the most crucial among the four financial statements, the income statement provides a comprehensive report of revenues, expenses, profits/losses, and net income (i.e. net profit). It offers a dynamic view of a company’s financial health and its ability to control expenses for enhanced profitability.

Investors rely on the income statement to discern trends and assess investment potential, while lenders scrutinize it to evaluate repayment capacity. That’s why accurate financial statement preparation is so critical to a company’s success.

The income statement includes three major components: revenue, expenses, and profit and loss.


Revenue includes the following:

  • Operating revenue. This represents income generated from a company’s core business activities, such as the sale of products or services. For example, a construction company’s operating revenue is derived from its construction and consulting activities.
  • Non-operating revenue. Income from peripheral activities falls under non-operating revenue. This can include interest earned on cash holdings, rental income from properties, royalty payment receipts income received from partnerships, and other sources unrelated to the primary business.
  • Other income. Gains from the sale of long-term assets, like land or vehicles, and revenues from activities beyond routine operations contribute to other income.


Expenses are categorized into primary and typical expenses:

  • Primary expenses include the cost of goods sold (COGS); selling, general, and administrative expenses (SG&A); depreciation or amortization; and research and development (R&D).
  • Typical expenditures encompass employee salaries, sales commissions, utilities, transportation, and costs associated with secondary activities such as the interest paid on loans or debt. Any losses that are incurred from the sale of assets are also recorded as an expense.

Profit or Loss

Profit represents the earnings a company generates from its operational activities, including gross, operating, and net profit. Loss, on the other hand, indicates a deficit in revenue compared to expenses. Both profit and loss are crucial metrics for assessing a company’s financial performance.

Income Statement Example

Let’s consider a fictitious company ABC Construction, Inc. located in Ft. Lauderdale, Florida, that builds new housing developments and high-rise condominiums.

ABC Construction, Inc.

Statement of Income 

for the year ended December 31, 2022

Contract revenue $85,500,000
Contract costs:
Labor and labor costs $2,350,000
Subcontractors 65,000,000
Materials 5,000,000
Equipment 90,000
Other costs 250,000
Total contract costs (72,690,000)
Gross profit from contracting 12,810,000
General and administrative expenses (2,290,000)
Income from operations 10,520,000
Other income (expense):
Interest income 195,000
Miscellaneous income 72,000
Interest expense (3,000)
Total other income, net 264,000
Income before income taxes 10,784,000
Income tax expense (2,264,000)
Net income $8,520,000

Balance Sheet: Assessing Assets and Liabilities

The balance sheet, the second most crucial financial statement, presents a static overview of a company’s financial position as of a specific date. As per the U.S. Securities and Exchange Commission (SEC), the balance sheet illustrates “what a company owns and what it owes at a fixed point in time,” by outlining its assets, liabilities, and shareholders’ equity.

The balance sheet is a crucial tool for stakeholders as it provides a comprehensive view of a company’s financial structure and offers valuable insights into a company’s liquidity and capitalization.

Its components include the following items: assets, liabilities, and shareholders’ equity.


The following constitute a company’s assets:

  • Current assets are items anticipated to be utilized, sold, or converted into cash within a year. Examples comprise cash, inventory, prepaid expenses, and amounts owed to the business by debtors (accounts receivable).
  • Non-current assets are items that cannot be converted into cash within a year and are utilized to operate the business, for example, property, buildings, and machinery. It also includes investments and intangible assets (trademarks, patents, and goodwill).


The following constitute a company’s liabilities:

  • Current liabilities are obligations to be settled within a year, such as the funds the business owes to creditors (accounts payable), wages payable, and impending payments on the overall long-term debt due within the next 12 months.
  • Non-current liabilities are long-term obligations, such as pension benefits, that extend beyond a one-year horizon and are not expected to be settled in the short term.

Shareholders’ Equity

Shareholders’ equity (stockholders’ equity) denotes the residual value of a company’s total assets after subtracting its total liabilities. It signifies the funds that would be distributed to shareholders if all assets were liquidated and all debts were settled.

Retained earnings constitute a segment of shareholders’ equity, representing the accumulated net earnings that haven’t been disbursed to shareholders in the form of dividends.

Balance Sheet Example

Consider ABC Construction, Inc.’s balance sheet.

ABC Construction, Inc.

Balance Sheet

for the year ended December 31, 2022

Current assets:
Cash and cash equivalents $5,200,000
Contracts – current $14,450,000
Contracts – retention 6,000,000
Other 39,000
Total receivables 20,489,000
Prepaid expenses 13,000
Total current assets 20,502,000
Property and equipment, net 320,000
Total assets $20,822,000
Liabilities and Stockholders’ Equity
Current liabilities:
Trade accounts payable:
Current 8,555,000
Subcontractor retentions 4,533,000
Total trade accounts payable 13,088,000
Current maturity of long-term debt 15,000
Total current liabilities 13,103,000
Long-term debt, net of current maturity 153,000
Total liabilities 13,256,000
Stockholders’ equity:
Common stock, no par value,

10,000 shares authorized,

2,300 shares issued and outstanding

Retained earnings



Total stockholders’ equity 7,566,000
Total liabilities and stockholders’ equity $20,822,000

Cash Flow Statement: Tracking Financial Movements

The cash flow statement (CFS) serves as a bridge between the income statement and the balance sheet, offering insights into how well a company generates cash to meet its obligations and fund operations and investments. The CFS enables investors to grasp the operational efficiency of a company, tracking its revenue sources, expenditure allocation, and overall financial stability.

It uses three major sections to offer valuable details about the company’s financial health and solidity.

Operating Activities

This section addresses cash generated or used in the day-to-day running of the business. It includes changes in cash accounts receivable, depreciation, inventory, and accounts payable. It also encompasses wages, interest payments, rent, income tax payments, and cash receipts derived from product or service sales.

Investing Activities

Investing activities involve cash transactions for the purchase or sale of assets and investments in the company’s long-term future. This includes acquisitions, mergers, and purchases of property, plant, and equipment (PPE).

Financing Activities

Financing activities reflect cash flows between the company and its capital providers, including transactions related to debt, equity, and dividends.

Cash Flow Statement Example

Consider ABC Construction, Inc.’s cash flow statement.

ABC Construction, Inc.

Cash Flow Statement

for the year ended December 31, 2022

Cash Flow From Operations
Net Earnings 8,520,000
Additions to Cash

Decrease in Accounts Receivable

Increase in Accounts Payable

Increase in Taxes Payable





Subtractions From Cash
Increase in Inventory (10,000)
Net Cash From Operations 8,603,000
Cash Flow From Investing
Equipment (90,000)
Cash Flow From Financing
Notes Payable 20,000
Cash Flow for FY Ended 31 Dec 2022 8,533,000

Statement of Retained Earnings: Understanding Equity Changes

The statement of retained earnings tracks changes in equity, reflecting share transactions, dividend payments, and profits or losses during a reporting period. While not as commonly used as the other statements, it provides valuable details about a company’s dividend policy and its ability to reinvest in the business. Understanding this statement is crucial for investors interested in a company’s distribution of profits and reinvestment strategies.

If your CPA firm produces a statement of retained earnings for your company, it will normally include the following sections.

Beginning Retained Earnings

This represents the retained earnings at the end of the previous period, rolling over to the current period. This figure appears on the balance sheet as shareholder equity.


Adjustments encompass modifications made by a company to its financial statements, addressing overestimations, underestimations, and revisions triggered by the receipt of tax benefits.

Net Income

Net income from the income statement is a key component, representing profits earned during the period.


Dividends paid to shareholders during the period are reported here.

Ending Retained Earnings

The resulting figure after accounting for the changes in net income and dividends reflects the retained earnings at the end of the current period.

Statement of Retained Earnings Example

Consider ABC Construction, Inc.’s statement of retained earnings.

ABC Construction, Inc.

Statement of Retained Earnings

for the year ended December 31, 2022

Retained earnings, January 1, 2022 $5,880,000
Net income 8,520,000
Total 14,400,000
Dividends paid (800,000)
Retained earnings, December 31, 2022 $13,600,000

Empowering Stakeholders With Financial Insights

Financial statements are indispensable tools for evaluating a company’s performance and financial health. They provide a foundation for informed decision-making, allowing stakeholders to assess a company’s past performance and future potential. Each financial statement plays a unique role, contributing specific insights into different aspects of a company’s financial landscape.

Armed with this knowledge, stakeholders, investors, and analysts can make informed assessments and strategic decisions for the future by understanding a company’s financial well-being, its ability to generate cash, and its potential for sustained growth. In the dynamic realm of corporate finances, a thorough understanding of financial statements is a powerful tool for those seeking to make sound investment and business decisions.

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