Financial statements are important sources of financial information that can be used to make sound business

decisions. This means that every component of financial statements is important. Components of a financial
statement can be described as the building blocks used for constructing the financial statement and these
items represent, in words and numbers, various resources, claims to those resources, and any transactions
that create changes in those resources and claims.
Below is a list of components of the most important financial statements – balance sheet, profit and loss
(P&L) statement, and cash flow statement - and their importance.

Components of Important Financial Statements

1. Balance Sheet
A Balance Sheet is a statement of the assets, liabilities, and capital of an organization at one particular point
in time. This statement gives an idea as to what the company owns and owes and also the amount of
shareholding. The critical components of this statement are as below.

 Assets:

An asset can be tangible or intangible and is often owned or controlled with the belief that it would provide
some future benefit and can be tangible or intangible. While the former includes current assets and fixed
assets, the latter refers to rights and other non-physical resources that provide value to the business. Current
assets consist of inventory, accounts receivables, and other short-term investments. Fixed assets could be
buildings, equipment, and other physical resources. Intangible assets usually include goodwill, copyright,
trademarks, and patents.

 Liabilities:

Liabilities are a company's legal debts or obligations that might arise during the course of business
operations. These are usually settled over time through the transfer of economic benefits like cash, goods, or
services. Liabilities include accounts payable, salaries or wages payable, interest due, customer deposits, and
other such obligations to third parties. Liabilities might be of two types - current or long-term. While the
former could be liquidated within a year, the latter can be repaid only in the long term (more than a year).
Long-term liabilities include long-term bonds issued by the firm, notes payables, leases, pension obligations,
and long-term product warranties.

 Equity or owner’s equity:

It is the residual assets of an entity that remain after deducting liabilities. Theoretically, this is the capital
available for distribution to shareholders. Hence, from a company’s liquidation perspective, equity would be
considered the residual claim on the assets of a business, available to shareholders, after liabilities have been
paid. For instance, if Company X has $3,000,000 as assets and $800,000 as liabilities, then equity would be
$2,200,000 (= $3,000,000 - $800,000). Equity usually comprises funds contributed by shareholders,
reserves, and retained earnings. Therefore, the only way to increase the amount of owners' equity is by either
getting more funds from investors or by increasing profits.

2. Profit and Loss Statement:

This statement is a summary of the financial performance of a business over time. This is usually prepared
after every quarter or year. The components in this statement include:

 Revenues:

The amount of cash that a company actually receives during a specific period, through the sale of goods or
services, is referred to as the company’s revenue. This would include discounts and deductions for returned
merchandise. Revenues would also include the amount received as a result of using the capital or assets of
the business as part of the operations of the business. Revenue is the "top line" or "gross income" of the
business.

 Expenses:

The outflow of money or incurring of liabilities (or a combination of both) through the production of goods,
rendering services, or carrying out any activity that would form a part of the business’s operations, are the
expenses of the company. Typical business expenses include wages or salaries, utilities such as rent,
depreciation of capital assets, and interest paid on loans. The purchase of an asset such as a building or
equipment is not an expense. Expenses also include the Cost of Goods Sold (COGS), which is the cost
incurred for selling goods during the period and includes import duties, freight, handling, and other costs for
converting inventory to finished goods.

 Gains:

A company’s gain is an increase in equity through peripheral or incidental transactions by a firm, other than
those from revenue or investments by owners (shareholders). It refers to any economic benefit that is outside
the normal operations of a business. Typically, gains refer to unusual and nonrecurring transactions, such as
gain on sale of land, change in a stock’s market price or a gift. It is often shown in the P&L statement as
non-operating income.

 Losses:

A company’s losses are decreases in equity through peripheral or incidental transactions carried out by the
firm, other than those from expenses or distributions to owners. This could be lost on the sale of an asset,
writing down of assets, or a loss from lawsuits. It could also include costs that give no benefit. It is often
shown in the P&L statement as a non-operating expense.

3. Cash Flow Statement:

This statement is a summary of the actual or anticipated inflows and outflows of cash in a firm over an
accounting period. This could be prepared at the end of a month, quarter or year. The cash flow statement
would reflect the liquidity position of the business. This is used as the basis for budgeting and business
planning. The components in this statement include:

 Cash Flow from Operating Activities:

Operating activities of a business refer to the production, sales, and delivery of the finished product and
collection of payments from customers. Cash outflows here could include purchasing raw materials,
advertising, and the cost of shipping the product. They might not include payment to suppliers, employees,
and interest payments. Depreciation and amortization are also included in the cash flow statement. Cash
inflows here consist of receipts from the sale of goods and services and interest received.
  Cash Flow from Investing Activities:

These are cash flows related to investments and include the purchase of assets, gains or losses through
investments in the financial market or in subsidiaries, and other related items.

 Cash Flow from Financing Activities:

This would account for activities that aid a firm in raising capital and repaying investors. The cash flow
might include cash dividends, adding or changing loans, or issues of stock. Cash flow from financing
activities reveals the company’s financial strength. Financing activities that produce positive cash flow
include cash from issued stocks and bonds. Financing activities that produce negative cash flow include cash
for repurchasing stock, paying off debt or interest, or payment of dividends to shareholders.

Every item in financial statements is important and provides insights into the workings and performance of
the firm. These components are useful to all stakeholders including the management, employees, suppliers,
and shareholders, for putting in place sound business plans and following a financially viable strategy.