FA Notes

1. What Are Financial Statements?

Financial statements are formal reports that summarize a business’s financial position and
performance. They are crucial for investors, lenders, and management to assess how well a
company is doing financially glasp.co.

2. The Big Three (Plus One)

a. Balance Sheet

• Snapshot in time (e.g., end of year)

• Shows:
o Assets: What the company owns

o Liabilities: What the company owes

o Equity: Owners' residual interest (Assets – Liabilities)

• Follows the equation:

Assets=Liabilities+Equity

• Example: Family-run "Tea-licious" had $169M in assets/liabilities and $129.5 M

equity
glasp.co+2accountingtools.com+2en.wikipedia.org+2rumble.com+4edu.lowcostlivin.
com+4accountingtools.com+4autuas.comyoutube.com.

b. Income Statement (Profit & Loss)

• Covers a period (month/quarter/year)

• Contains:

o Revenue

o Expenses

o Net profit or loss

• Example: Tea-licious earned $255 M, spent $248 M, netting $7 M

en.wikipedia.org+1glasp.co+1en.wikipedia.org+6autuas.com+6accountingtools.com+
6.

c. Cash Flow Statement

• Tracks cash movement over a period

• Three categories:
 o Operating activities

o Investing activities

o Financing activities

• Example: Tea-licious increased cash from $11 M to $12 M, net +$1 M

rumble.com+14autuas.com+14en.wikipedia.org+14.

3. Cash vs. Accrual Accounting

• Cash-basis: Recognize income/expenses when cash changes hands

• Accrual-basis: Recognize earnings/expenses when incurred, regardless of cash flow

• Cash flow statement reconciles accrual income to actual cash movement

rumble.com+6autuas.com+6accountingtools.com+6.

4. Purposes & Key Takeaways

Statement Purpose

Balance Sheet Snapshot of financial position: liquidity & leverage

Income Statement Shows profitability over time

Cash Flow Highlights liquidity—can the business pay bills?

• Together, they offer a comprehensive view of a business’s financial health

accountingtools.com+14glasp.co+14en.wikipedia.org+14autuas.com.

• Essential for evaluating performance, stability, and growth potential.

5. Example Case: “Tea-licious”

• Balance Sheet: $169M assets = $169M liabilities; $129.5M equity

• Income Statement: $255M revenue – $248M expenses = $7M net profit

• Cash Flow: Cash rose from $11M to $12M → +$1M net cash inflow autuas.com
6. Summary

• Track structure and purpose:

o Balance sheet = who owns what

o Income statement = profitability

o Cash flow = funds in and out

o Retained earnings = changes in owners' stake

• Understand which accounting method is used (cash vs. accrual)
 • Use together to make financially sound decisions

Balancesheet

1. What Is a Balance Sheet?

• A snapshot of a company’s financial position at a specific moment.

• It consists of:

o Assets: What the company owns

o Liabilities: What the company owes

o Equity: Owners' stake in the company

• The fundamental equation:
Assets = Liabilities + Equity

2. Structure & Classification

• Assets:

o Current (e.g., cash, inventory)

o Non-current (e.g., property, equipment)

• Liabilities:
o Current (due within 1 year)

o Non-current (long-term obligations)

• Equity: Includes invested capital and retained earnings

3. Example Walkthrough (“Tea-licious”)

• Assets and liabilities each total $169 million

• Owner’s equity tally: $129.5 million

4. Why Does It Matter?

• Indicates liquidity (ability to meet short-term obligations)

• Shows use of leverage: How much debt is used to fund assets

• Helps evaluate financial stability and risk

5. Relationship to Other Financial Statements
 • The balance sheet provides the foundation for the:

o Income Statement (period-based profitability)

o Cash Flow Statement (actual cash movement)

• It’s essential for computing ratios like:

o Current ratio (Liquidity)

o Debt-to-equity ratio (Solvency)

6. Key Takeaways

• Always check that Assets = Liabilities + Equity

• Differentiate between short-term vs long-term

• Use alongside other statements for comprehensive analysis

Income Statement
1. What Is an Income Statement?

• Shows a company’s financial performance over a period (e.g., month, quarter, year).

• Also known as Profit and Loss Statement (P&L).

2. Core Components of the Income Statement

• Revenue (or Sales): Income from business operations.

• Expenses: Costs incurred to generate revenue, categorized as:

o Cost of Goods Sold (COGS) – direct costs of producing goods/services

o Operating Expenses – such as rent, salaries, depreciation

o Interest Expense – cost of borrowing

o Taxes – government obligations

• Net Income = Revenue – All Expenses

o If positive → Profit

o If negative → Loss
3. Sample Income Statement Walkthrough

• Revenue example: $255 million

• Expenses: $248 million
 • Net Income: $7 million

4. Importance of the Income Statement

• Tracks profitability trends over time.

• Provides key metrics:

o Profit margin (Net Income ÷ Revenue)

o GP Margin, Operating Margin, etc.

• Helps in making informed decisions about pricing, cost controls, and growth.

5. Components & Subtotals

Typical structure:

1. Revenues/Sales

2. Subtract COGS → Gross Profit

3. Subtract Operating Expenses → Operating Income
4. Subtract Interest → Earnings Before Taxes (EBT)

5. Subtract Taxes → Net Income

6. Performance Indicators

• Year-over-Year Comparison: Revenue growth, margin expansion

• Trends analysis: Are revenues rising faster than costs?

• Variances: Explore unexpected changes in expenses

7. Interconnections
• Net Income also influences:

o Balance Sheet (via retained earnings)

o Cash Flow Statement (via operating cash flows)

8. Practical Uses

• Business owners analyze income statements to:

o Determine whether the firm is making money

o Identify cost-saving opportunities

o Set realistic performance targets

Key Takeaway
The income statement provides a clear view of a company’s profitability, taking into
account all revenue streams and costs. It’s critical for internal decision-making and external
financial analysis.

Cashflow Statement
1. Purpose of the Cash Flow Statement

• Summarizes cash inflows and outflows over a specific period (e.g., a year).

• Helps distinguish between cash accounting and accrual accounting.

• Essential for understanding a business’s liquidity and ability to pay bills

cceta.org+12deciphr.ai+12youtube.com+12.

2. Cash vs. Accrual Accounting

• Cash-basis: Records revenue/expenses when cash actually changes hands.

• Accrual-basis: Records earnings and expenses when they’re incurred—cash

movement may occur later.
• The cash flow statement is required under accrual accounting (alongside income
statement and balance sheet)
3. Three Sections of the Statement

1. Operating Activities

o Cash from core business operations

o Adjusts net income to cash basis by adding back non-cash items (depreciation,
amortization) and accounting for changes in working capital (e.g., inventories,
receivables, payables) youtube.comanswers.microsoft.com

2. Investing Activities

o Cash used for buying/selling long-term assets (equipment, property,

investments)

3. Financing Activities

o Cash from debt or equity issuance, and outflows such as debt repayment and
dividends
cceta.org+2answers.microsoft.com+2pearson.com+2en.wikipedia.org+1answe
rs.microsoft.com+1

4. Methods for Preparing the Statement

• Direct Method: Lists actual cash receipts/payments (e.g. cash from customers, cash
paid to suppliers). Clearer but less commonly used
pearson.com+6deciphr.ai+6youtube.com+6.
 • Indirect Method: Starts with net income, adjusts for non-cash items and working
capital changes. Most commonly used
en.wikipedia.org+2deciphr.ai+2answers.microsoft.com+2.

5. Using the Indirect Method: Step-by-Step

1. Start with net income from the income statement.

2. Add back non-cash expenses: depreciation, amortization.

3. Adjust for working capital changes:

o Increase in current assets ➝ subtract

o Increase in current liabilities ➝ add

4. Include non-operating gains/losses:

o Subtract gains; add losses (like asset sales)

Example: If net income is $100,000 and receivables increase by $25,000 → cash from
operations = $100K – $25K = $75K .

6. Sample Company: “Tumble” (Fictional Start-Up)

• Illustrates cash flow with:

1. Net income

2. Depreciation added back

3. Working capital adjustments

4. Investing/financing activity impacts

7. Why It Matters

• Shows the quality of earnings—i.e., how much of the profit is actual cash.

• Crucial for assessing whether a company can cover debt, reinvest, or pay dividends
en.wikipedia.org.

• Complements the balance sheet and income statement for a full financial picture.

8. Comparison: Direct vs. Indirect (Quick Take)

Method Pros Cons

Easy to
Direct Harder to prepare
read
Method Pros Cons

Easier to
prepare Less intuitive format
Indirect (most youtube.com+4deciphr.ai+4answers.microsoft.com+4youtube.com+
items are 2en.wikipedia.org+2pearson.com+2
available)

Key Takeaways

• The cash flow statement is vital for financial health, tracking liquidity across
periods.

• Understanding it requires linking it with the income statement and balance sheet.

• The indirect method is most widely used for operating activities.

• Use this statement to evaluate cash strength, not just profitability.