The Four Types of Financial Statements Explained

Businesses use four types of standardized statements to measure their financial performance and health. Investors, shareholders and other stakeholders use the information in these statements to make decisions about a company’s stability and potential. These are the four types of financial statements:¹

• Income statement
• Balance sheet
• Cash flow statement
• Statement of retained earnings

This blog post will cover the four types of financial statements and why they’re important to a company’s operations.

What Is a Financial Statement?

A financial statement is a standardized report that summarizes a particular aspect of a company’s accounting. Financial statements allow people to clearly understand a company’s financial performance and compare it to other companies. These statements are used to make informed decisions about a range of activities. Investors use them to determine if they want to invest in a company. Lenders use them to evaluate whether they should loan money. Business leaders use them for strategic planning.²

What Are the Different Types of Financial Statements?

One financial report alone isn’t enough to provide a complete overview of a company’s performance. You need to examine financial performance from multiple perspectives to gain a clear understanding. A company’s income statement may look profitable, but its cash flow statement might show that it has a problem with liquidity that puts it at risk for not meeting short-term obligations such as payroll or vendor payments. To see the whole picture, you need to consider all four statements: income, balance, cash flow and retained earnings.³

Income Statement

An income statement tracks a company’s revenue and expenses over a set period of time. It’s also called a profit and loss (P&L) statement. An income statement concludes with the net income a business has earned during the covered period. It includes all types of revenue, including operating revenue generated by selling a company's products or services.⁴

It also includes non-operating revenue, which is the income earned from activities that fall outside of its primary function. Some examples are rental income from a property, interest earned on cash in the bank and income from an ad display on the company’s property. Income statements also have a place to report other income, such as gains from the sale of long-term assets.⁴

An income statement reports primary expenses that a company incurs as a result of earning money from its primary activity, such as the cost of materials or research and development, as well as general administrative expenses. Typical expenses, such as employee wages and utility costs, and other expenses associated with secondary activities, such as interest on loans or debt, are also reported on the income statement.⁴

Balance Sheet

The balance sheet is a snapshot of a company’s assets, liabilities and shareholder equity on a specific date. It presents a clear summary of what a business owns and what it owes. Accurate financial records are crucial for preparing a balance sheet since it includes information from many different business activities.⁵

The accounting equation for a balance sheet is Total assets = Total liabilities + Shareholders’ equity.⁵

The following table illustrates the five main parts of a balance sheet:⁵

Cash Flow Statement

The cash flow statement (CFS) measures how well the company generates cash to pay its debts and fund its operating expenses and investments. It helps investors see whether or not the company is on strong financial ground by showing where its money comes from and how it’s being spent.

The CFS is used to reconcile the income statement with the balance sheet. It includes the finances of operating activities such as running the business and selling its products or services. These can include any changes made in cash accounts receivable, depreciation, inventory and accounts payable, such as wages, income tax payments, interest payments, rent and cash receipts from the sale of a product or service.

The investing activities section details cash from the company's investments in its long-term future. This includes the purchase or sale of an asset, loans made to vendors or received from customers and any payments related to a merger or acquisition.

Financing activities reported on a CFS show the net cash flows that are used to fund the company, such as transactions involving debt, equity and dividends.

There are two methods of reporting cash flow activities: direct and indirect. The direct reporting method lists actual cash transactions and provides clear visibility of cash movement. The indirect method of reporting starts with net income and makes adjustments for non-cash items. This is less transparent but easier to prepare. The indirect method is the most common form and is used by most large companies.⁶

Statement of Changes in Equity (or Retained Earnings)

The statement of retained earnings shows changes in equity—including changes caused by reported profits or losses, dividend payments and the sale or repurchase of shares—during a given reporting period. It’s the least commonly used of the financial statements, and it’s typically only included in a company's audited financial statement package.

However, there are times when this document is necessary, such as when reporting to the board and shareholders about how much profit has been retained vs. distributed. Companies may also need to provide this statement as part of a merger or acquisition or on credit applications. Business leaders often use retained earnings statements to make strategic decisions.⁷

Financial Statement Requirements and Regulations

Companies must follow strict standards when preparing financial statements to facilitate transparency and consistency. The Generally Accepted Accounting Principles (GAAP) and the International Financial Reporting Standards (IFRS) are the two primary accounting frameworks that businesses follow.⁸

Both frameworks require the same core financial statements, but there are several notable differences:⁸

• The IFRS requires one year of comparatives, while companies that use GAAP are typically required to provide two
• The IFRS classifies debt based on reporting data only, while the GAAP allows post-date reclassification
• The IFRS expense format is by function or nature, while the GAAP can be single or multi-step format

Companies are now also required to comply with digital financial reporting mandates in order to facilitate compatibility and digital audit trails.

How Different Types of Financial Reports Are Prepared

The first step in preparing business financial statements is choosing a reporting standard. The GAAP is most common in the US, and the IFRS is often used by international companies. Accountants gather and analyze financial data for the time period of the reports and record the transactions according to the framework. They compile and review the statements to ensure they’re accurate and consistent.⁹

Modern accounting software, such as QuickBooks and Oracle NetSuite, makes the process of collecting financial data easier. AI-driven platforms such as Datarails can perform real-time analysis and scenario modeling with financial data.¹⁰

Turn Your Passion for Numbers Into a Successful Career

William & Mary’s Online Master of Accounting (MAcc) program will prepare you to transform financial data into actionable insights that business leaders can use to drive sustainable results. You can advance your career on your own schedule, no matter where you live. Our rigorous curriculum will prepare you to tackle complex business challenges head-on, while giving you opportunities to learn from industry experts. Contact one of our admissions outreach advisors today to learn more.