Corporate financial statements and reports (Part I)

In this series of articles, we will discuss the different types of financial statements required of a corporation by US GAAP and the different reports required of public companies by the Securities and Exchange Commission. For this part 1, we will give a brief overview of the major financial statements produced by a corporation - balance sheet, income statement, statement of shareholders’ equity, cash flow statement and related footnotes.

1. Balance sheet

For the second part of this article series, refer to Corporate financial statements and reports (Part II).

The balance sheet gives a snapshot at a single point in time of all the company’s accounts separated into assets, liabilities, and equity. Short-term assets and liabilities and listed before long-term assets and liabilities. A one-year cutoff point is usually appropriate for the distinction between short-term and long-term. Current-year balance sheets normally display information from last year’s balance sheet for comparison purposes.  See this article on how to prepare a balance sheet.

2. Income statement

The income statement shows the results of operating and nonoperating income and expenses for the period. The company’s normal course of business usually defines the difference between operating and nonoperating - selling a product is an operating activity, while a loss due to natural disaster is not. This statement adds up all revenues for the period and subtracts all expenses - including income taxes - to arrive at net income (or loss) for the period. Like the balance sheet, the income statement usually discloses information for prior periods.

3. Statement of shareholders’ equity

This statement shows all changes to the company’s equity accounts including retained earnings. Net income from the income statement is added to beginning retained earnings, and any dividends paid to shareholders are subtracted to arrive at ending retained earnings.  Other equity accounts include common stock, preferred stock, treasury stock and so on.

4. Cash flow statement

The cash flow statement gives a comprehensive view of how the company managed its available cash. The statement is normally split up into three sections. The operating activities section describes cash flows from day-to-day operating activities such as cash received from customers and cash paid to suppliers. The investing activities section lists activities such as capital expenditures and sales of capital assets. Finally, the financing activities section lists items such as stock sales and repurchases and the payment of cash dividends.

The operating activities section can be completed using either the direct method or the indirect method. The former version directly lists all specific classes of cash flows. The indirect method starts with net income and works backwards by taking into account noncash income items and changes in asset accounts for the year to arrive at operating cash flow.

5. Financial statement notes and other disclosures

In order to conform to US GAAP, companies need to disclose additional significant notes about the company’s operations. These notes are quite diverse, ranging from notes about accounting policies and estimates - such as whether the company uses LIFO or FIFO for inventory purposes - to a figure showing a calculation of basic and diluted earnings per share. In general, any information not fully disclosed in the major financial statements that an investor might think is relevant should be disclosed in the notes. For example, many large corporations regularly disclose an uncertainty about pending litigation, because an investor might want to know that the company could be liable for a multimillion dollar settlement in the near future. Another example might be the full disclosure of pension arrangements.

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