3 Types of Financial Statements and their importance?

Balance Sheet, profit and Loss Statement and Cash Flow Statement

Financial Statements are one of the most important part of every business.

Under the Section 211 of the Indian Companies Act, 1956 it is required that Profit and loss a/c and balance sheet of the company should give the true and fair picture of the financial affairs of the company.

But the thing is for some (or most) people reading those statements can be daunting.

The good news is you can start reading financial statements of a company just after knowing some terms and basic stuff.

Moreover, if you are an investor then you will be reading a lot of financial statements to reach to decisions.

Reading financial statements is needed in almost every aspect of business whether you belong to the

top line or an investor looking to invest in that company.


Types of Financial Statements

There are three basic financial statements of a company:-

(A) Statement of Profit and Loss – Statement of profit and loss shows the net result of business operations i.e. financial performance (profit earned or loss suffered) during an accounting period.

(B) Balance Sheet – Balance Sheet is defined as a statement of assets and liabilities of the company at a particular date.

(C) Cashflow Statement – A cash flow statement is a statement showing inflows (receipts) and outflows (payments) of cash and cash equivalents of the business during a particular period.

From above three types of financial statements Statement of profit and loss and balance sheet are very important.

For reader convenience Profit and Loss a/c is shown first and the balance sheet is shown afterwards.

Further, it is required that report of Auditor and Board of Directors should be attached with the Profit and Loss a/c and Balance Sheet of every year.

( Note– You may find in some places that there are more than 3 types of financial statements, but these three

are most asked and vital [Statement of changes in equity and notes to accounts are another two])

Now that you have understood the 3 types of financial statements, its time to get hang of them and study them by heart so next time when you look at it, you know what is what.


Objectives of Financial Statements

  1. To provide financial data on economic resources (assets) and obligations (liabilities) of an enterprise.
  2. To provide the information about the earning capacity.
  3. To provide sufficient and reliable information to various parties interested in financial statements
  4. To present a fair and true view of working of the company
  5. To serve as the basis for future panning and implementation of various operations.
  6. To help to judge the effectiveness of management.
  7. To disclose various accounting policies.

Characteristics fo Financial Statements

  1. Financial Statements relate to a specific past period and thus are historical in nature.
  2. Financial Statements are expressed in monetary terms.
  3. Financial Statements show profitability through the statement of profit and loss and financial position through the balance sheet.

Format of Balance Sheet

Balance Sheet may be defined as a statement of assets and liabilities of the company at a particular date.

Balance Sheet is prepared and presented in the form prescribed in Schedule III, Part I of the Companies Act, 2013.

The form prescribed is vertical.

Balance Sheet is one of the most important types of financial statements thus it must exhibit a true and fair view of the financial position of the company at the close of the year.

Following is the format prescribed in Schedule III, Part I of the Companies Act, 2013 and you can check other

formats and other important guidelines by reading Schedule III from here.

Format of Balance Sheet in types of financial statements of a company
Format of Balance Sheet (1)
Format of Balance Sheet in types of financial statements of a company
Format of Balance Sheet (2)

In the coming section, you will read some important terms and above heads and sub-heads in detail.


Important points in the Balance Sheet

An asset shall be classified as current when it satisfies any of the following criteria:—

  1. it is expected to be realised in or is intended for sale or consumption in, the
  2. company’s a normal operating cycle;
  3. it is held primarily for the purpose of being traded;
  4. it is expected to be realised within twelve months after the reporting date; or
  5. it is cash or cash equivalent unless it is restricted from being exchanged or used to settle a liability for at least twelve months after the reporting date.

All other assets shall be classified as non-current.

An operating cycle is the time between the acquisition of assets for processing and their realisation in cash or cash equivalents.

Where the normal operating cycle cannot be identified, it is assumed to have a duration of twelve months.

A liability shall be classified as current when it satisfies any of the following criteria:—

  1. it is expected to be settled in the company’s normal operating cycle;
  2. it is held primarily for the purpose of being traded;
  3. it is due to be settled within twelve months after the reporting date; or
  4. the company does not have an unconditional right to defer settlement of the liability for at least twelve months after the reporting date.

Terms of a liability that could, at the option of the counterparty, result in its settlement by the issue of equity

instruments do not affect its classification.

All other liabilities shall be classified as non-current.

A receivable shall be classified as a “trade receivable” if it is in respect of the amount due on account of goods sold or services rendered in the normal course of business.

A payable shall be classified as a “trade payable” if it is in respect of the amount due on account of goods purchased or services received in the normal course of business.

A company shall disclose the following in the notes to accounts.

Read more about financial market through this Financial market post.

Share Capital

For each class of share capital (different classes of preference shares to be treated separately):

(a) the number and amount of shares authorised;

(b) the number of shares issued, subscribed and fully paid, and subscribed but not fully paid;

(c) par value per share;

(d) a reconciliation of the number of shares outstanding at the beginning and at the end of the reporting period;

(e) the rights, preferences and restrictions attaching to each class of shares including restrictions on the distribution of dividends and the repayment of capital;

(f) shares in respect of each class in the company held by its holding company or its ultimate holding company including shares held by or by subsidiaries or associates of the holding company or the ultimate holding company in aggregate and important in types of financial statements

(g) shares in the company held by each shareholder holding more than 5 per cent. shares specifying the number of shares held;

(h) shares reserved for issue under options and contracts/commitments for the sale of shares/disinvestment, including the terms and amounts;

(i) for the period of five years immediately preceding the date as at which the Balance Sheet is prepared:

Reserves and Surplus

(i) Reserves and Surplus shall be classified as:

  1. Capital Reserves;
  2. Capital Redemption Reserve;
  3. Securities Premium Reserve;
  4. Debenture Redemption Reserve;
  5. Revaluation Reserve;
  6. Share Options Outstanding Account;
  7. Other Reserves–(specify the nature and purpose of each reserve and the amount in respect thereof);

(h) Surplus i.e., balance in Statement of Profit and Loss disclosing allocations and appropriations such as dividend, bonus shares and transfer to/ from reserves, etc.;

(Additions and deductions since last balance sheet to be shown under each of the specified heads);

(ii) A reserve specifically represented by earmarked investments shall be termed as a “fund”.

(iii) Debit balance of statement of profit and loss shall be shown as a negative figure under the head “Surplus”. Similarly, the balance of “Reserves and Surplus”, after adjusting negative balance of surplus, if any, shall be shown under the head “Reserves and Surplus” even if the resulting figure is in the negative.

Long-Term Borrowings

(i) Long-term borrowings shall be classified as:

  • Bonds/debentures;
  • Term loans:
  • from banks.
  • from other parties.
  • Deferred payment liabilities;
  • Deposits;
  • Loans and advances from related parties;
  • Long term maturities of finance lease obligations;
  • Other loans and advances (specify nature).

(ii) Borrowings shall further be sub-classified as secured and unsecured.

Nature of security shall be specified separately in each case.

(iii) Where loans have been guaranteed by directors or others, the aggregate amount of such loans under each head shall be disclosed in types of financial statements

(iv) Bonds/debentures (along with the rate of interest and particulars of redemption or conversion, as the case may be) shall be stated in descending order of maturity or conversion, starting from farthest redemption or conversion date, as the case may be.

Where bonds/debentures are redeemable by instalments, the date of maturity for this purpose must be reckoned as the date on which the first instalment becomes due.

(v) Particulars of any redeemed bonds/debentures which the company has the power to reissue shall be disclosed.

(vi) Terms of repayment of term loans and other loans shall be stated.

(vii) Period and amount of continuing default as on the balance sheet date in repayment of loans and interest, shall be specified separately in each case.

Other Long-term Liabilities

Other Long-term Liabilities shall be classified as:

(a) Trade payables;

(b) Others.

Long-term provisions

The amounts shall be classified as:

(a) Provision for employee benefits;

(b) Others (specify nature).

Short-term borrowings

(i) Short-term borrowings shall be classified as:

(a) Loans repayable on demand;

(A) from banks.

(B) from other parties.

(b) Loans and advances from related parties;

(c) Deposits;

(d) Other loans and advances (specify nature).

(ii) Borrowings shall further be sub-classified as secured and unsecured.

Nature of security shall be specified separately in each case in types of financial statements.

(iii) Where loans have been guaranteed by directors or others, the aggregate amount of such loans under each head shall be disclosed.

(iv) Period and amount of default as on the balance sheet date in repayment of loans and interest, shall be specified separately in each case in types of financial statements.

Other current liabilities

The amounts shall be classified as:

  1. Current maturities of long-term debt;
  2. Current maturities of finance lease obligations;
  3. Interest accrued but not due on borrowings;
  4. Interest accrued and due on borrowings;
  5. Income received in advance;
  6. Unpaid dividends;

Short-term provisions

The amounts shall be classified as:

(a) Provision for employee benefits.

(b) Others (specify nature) in types of financial statements.

Tangible assets

(i) Classification shall be given as:

  • Land;
  • Buildings;
  • Plant and Equipment;
  • Furniture and Fixtures;
  • Vehicles;
  • Office equipment;
  • Others (specify nature).

(ii) Assets under lease shall be separately specified under each class of asset.

(iii) A reconciliation of the gross and net carrying amounts of each class of assets at the beginning and end of the reporting period showing additions, disposals, acquisitions through business combinations and other adjustments and the related depreciation and impairment losses/reversals shall be disclosed separately in types of financial statements.

(iv) Where sums have been written-off on a reduction of capital or revaluation of assets or where sums have been added on revaluation of assets, every balance sheet subsequent to the date of such write-off, or addition shall show the reduced or increased figures as applicable and shall by way of a note also show the amount of the reduction or increase as applicable together with the date thereof for the first five years subsequent to the date of such reduction or increase.

Intangible assets

(i) Classification shall be given as:

(a) Goodwill;

(b) Brands /trademarks;

(c) Computer software;

(d) Mastheads and publishing titles;

(e) Mining rights;

(f) Copyrights, and patents and other intellectual property rights, services and operating rights;

(g) Recipes, formulae, models, designs and prototypes;

(h) Licences and franchise;

(i) Others (specify nature).

(ii) A reconciliation of the gross and net carrying amounts of each class of assets at the beginning and end of the reporting period showing additions, disposals, acquisitions through business combinations and other adjustments and the related amortization and impairment losses/reversals shall be disclosed separately.

(iii) Where sums have been written-off on a reduction of capital or revaluation of assets or where sums have been added on revaluation of assets, every balance sheet subsequent to the date of such write-off, or addition shall show the reduced or increased figures as applicable and shall by way of a note also show the amount of the reduction or increase as applicable together with the date thereof for the first five years subsequent to the date of such reduction or increase in types of financial statements.

Non-current investments

(i) Non-current investments shall be classified as trade investments and other investments and further classified as:

  • (a) Investment property;
  • (b) Investments in Equity Instruments;
  • (c) Investments in preference shares;
  • (d) Investments in Government or trust securities;
  • (e) Investments in debentures or bonds;
  • (f) Investments in Mutual Funds;
  • (g) Investments in partnership firms;
  • (h) Other non-current investments (specify nature).

Under each classification, details shall be given of names of the bodies corporate indicating separately whether such bodies are

(i) subsidiaries,

(ii) associates,

(iii) joint ventures, or

(iv) controlled special purpose entities in whom investments have been made and the nature and extent of the investment so made in each such body corporate (showing separately investments which are partly-paid).

In regard to investments in the capital of partnership firms, the names of the firms (with the names of all their partners, total capital and the shares of each partner) shall be given of types of financial statements.

(ii) Investments carried at other than at cost should be separately stated specifying the basis for valuation thereof;

(iii) The following shall also be disclosed:

(a) Aggregate amount of quoted investments and market value thereof;

(b) Aggregate amount of unquoted investments;

(c) Aggregate provision for diminution in value of investments.

Long-term loans and advances

(i) Long-term loans and advances shall be classified as:

(a) Capital Advances;

(b) Security Deposits;

(c) Loans and advances to related parties (giving details thereof);

(d) Other loans and advances (specify nature).

(ii) The above shall also be separately sub-classified as:

(a) Secured, considered good;

(b) Unsecured, considered good;

(c) Doubtful.

(iii) Allowance for bad and doubtful loans and advances shall be disclosed under the relevant heads separately.

(iv) Loans and advances due by directors or other officers of the company or any of them either severally or jointly with any other persons or amounts due by firms or private companies respectively in which any director is a partner or a director or a member should be separately stated for types of financial statements.

Other non-current assets

Other non-current assets shall be classified as:

(i) Long-term Trade Receivables (including trade receivables on deferred credit terms);

(ii) Others (specify nature);

(iii) Long term Trade Receivables, shall be sub-classified as:

(A) (a) Secured, considered good;

(b) Unsecured, considered good;

(c) Doubtful.

(B) Allowance for bad and doubtful debts shall be disclosed under the relevant heads separately in types of financial statements.

(C) Debts due by directors or other officers of the company or any of them either severally or jointly with any other person or debts due by firms or private companies respectively in which any director is a partner or a director or a member should be separately stated.

Current Investments

(i) Current investments shall be classified as:

(a) Investments in Equity Instruments;

(b) Investment in Preference Shares;

(c) Investments in Government or trust securities;

(d) Investments in debentures or bonds;

(e) Investments in Mutual Funds;

(f) Investments in partnership firms;

(g) Other investments (specify nature).

Under each classification, details shall be given of names of the bodies corporate

[indicating separately whether such bodies are:

(i) subsidiaries,

(ii) associates,

(iii) joint ventures, or

(iv) controlled special purpose entities] in whom investments have been made and the nature and extent of the investment so made in each such body corporate (showing separately investments which are partly paid).

In regard to investments in the capital of partnership firms, the names of the firms (with the names of all their partners, total capital and the shares of each partner) shall be given in types of financial statements.

(ii) The following shall also be disclosed:

(a) The basis of valuation of individual investments;

(b) Aggregate amount of quoted investments and market value thereof;

(c) Aggregate amount of unquoted investments;

(d) Aggregate provision made for diminution in value of investments.

Inventories

(i) Inventories shall be classified as:

(a) Raw materials;

(b) Work-in-progress;

(c) Finished goods;

(d) Stock-in-trade (in respect of goods acquired for trading);

(e) Stores and spares;

(f) Loose tools;

(g) Others (specify nature).

(ii) Goods-in-transit shall be disclosed under the relevant sub-head of inventories.

(iii) Mode of valuation shall be stated.

Trade Receivables

(i) Aggregate amount of Trade Receivables outstanding for a period exceeding six months from the date they are due for payment should be separately stated.

(ii) Trade receivables shall be sub-classified as:

(a) Secured, considered good;

(b) Unsecured, considered good;

(c) Doubtful.

(iii) Allowance for bad and doubtful debts shall be disclosed under the relevant heads separately in types of financial statements.

(iv) Debts due by directors or other officers of the company or any of them either severally or jointly with any other person or debts due by firms or private companies respectively in which any director is a partner or a director or a member should be separately stated in types of financial statements.

Cash and cash equivalents

(i) Cash and cash equivalents shall be classified as:

(a) Balances with banks;

(b) Cheques, drafts on hand;

(c) Cash on hand;

(d) Others (specify nature).

(ii) Earmarked balances with banks (for example, for unpaid dividend) shall be separately stated.

(iii) Balances with banks to the extent held as margin money or security against the borrowings, guarantees, other commitments shall be disclosed separately.

(iv) Repatriation restrictions, if any, in respect of cash and bank balances shall be separately stated.

(v) Bank deposits with more than twelve months maturity shall be disclosed separately.

Short-term loans and advances

(i) Short-term loans and advances shall be classified as:

(a) Loans and advances to related parties (giving details thereof);

(b) Others (specify nature).

(ii) The above shall also be sub-classified as:

(a) Secured, considered good;

(b) Unsecured, considered good;

(c) Doubtful.

(iii) Allowance for bad and doubtful loans and advances shall be disclosed under the relevant heads separately.

(iv) Loans and advances due by directors or other officers of the company or any of them either severally or jointly with any other person or amounts due by firms or private companies respectively in which any director is a partner or a director or a member shall be separately stated in types of financial statements.

Other current assets (specify nature)

This is an all-inclusive heading, which incorporates current assets that do not fit into any other asset categories.

That’s all you need or should know about Balance Sheet now next section is going to talk about P&L.


Format of Statement of Profit and Loss

Statement of Profit and loss shows the net result of business operations i.e. financial performance (profit earned or loss suffered) during an accounting period.

The vertical format is prescribed under Schedule III, Part II of the Companies Act, 2013

Profit and Loss Statement
Profit and Loss Statement

Important terms in statement of P&L

Revenue from operations

Revenue from Operations means revenue earned by the company from its business operations (i.e. its operating activities) e.g. sale of products is an operating activity for a manufacturing company or a trading company.

Similarly, interest earned on loans and advances or dividend earned by a financing company is revenue from operations for a financing company.

Revenue from operations is to be classified into

(i) Sale of products

(ii) Sale of services

(iii) Other operating revenues

In the case of a finance company, revenue from operations shall include revenue from

(i) Interest

(ii) Dividend

(iii) Income from financial services

(iv) Net gain/loss on the sale of investments

Other Income

Other income means revenue that is not revenue fror operations.

Other income is to be classified into

(i) Interest income (In case of a company other than a finance company).

(ii) Dividend income (In case of a company other than a finance company).

(iii) Net gain on sale of fixed assets.

(iv) Other non-operating income (Net of expenses directly attributable to such income).

(v) Excess provision written back.

(vi) Bad debts recovered

Expenses

Expenses are to be classified into:-

(A) Cost of Material Consumed

It relates to a manufacturing company. It will consist of raw materials and other materials consumed in the

process of manufacturing.

In simple words,

Cost Of Material Consumed = Opening Inventory of materials

+ Purchase of Materials – Closing Inventory Materials

(B) Purchase of Stock in Trade

It relates to companies engaged in trading i.e. purchase and sale of goods.

Thus, it means and includes goods purchased with the purpose to resell.

If the company carries out further processing on the goods purchased, then they do not remain stock-in-trade but become part of the materials consumed.

(C) Changes in Inventories of Finished Goods, Work in Progress and Stock in Trade

It is the difference between the opening inventories and closing inventories.

It is to be disclosed separately for raw materials, work-in-progress and stock-in-trade.

(D) Employees Benefit Expense

These are those expenses which are incurred on employees of the company. It will include expenses on

(a) Salaries and wages on

(b) Bonus, leave encashment, etc

(c) Staff welfare expenses

(d) Contribution to provident fund and other funds

(e) Employee State Insurance (ESI)

(f) Gratuity payments 2006

(g) Contribution to gratuity fund Employees benefit expense can be divided into direct and indirect expense.

(F) Finance Costs

It means expenses incurred on borrowings (loans taken) by the company. It is classified into

(a) Interest Expenses It includes interest paid on term loans from bank, overdraft, cash credit limit from bank, debentures, public deposits and bonds.

(b) Other Borrowing Costs It includes discount or loss on issue of debentures written-off, premium payable on redemption of debentures written-off, loan processing charges, guarantee charges, commitment charges, commission paid for deposit mobilisation.

Bank charges will not be shown under this head because it is not interest on borrowings but is a cost for services availed from the bank. It will be shown under ‘other expenses’.

(G) Depreciation and Amortisation Expense

Depreciation means writing-off the amount related to fixed tangible assets over their useful life.

Depreciation is the diminution in the value of fixed assets whereas, amortisation means writing-off intangible assets.

(H) Other Expenses

All other expenses, which do not fall in the above categories, are shown or classified under ‘other expenses.

Other expenses may further be categorised into direct expenses, indirect expenses and non-operating expenses.

For Example – Consumption of loose tools (spare parts), stores, power and fuel, carriage, carriage inwards carriage outwards, freight, manufacturing expenses, rent, rates and taxes (excluding tax on income), insurance less prepaid (if any), discount allowed, commission allowed, bad debts written-off, provision for bad debts, repairs to machinery, building and other fixed assets, trade expenses, administration, office and telephone expenses, excise duty paid, prior period expenses, bank charges, loss on sale of fixed assets, lease rent and computer hiring charges, director’s fees, audit fee, conveyance expenses, travelling expenses, courier expenses, telephone and internet expenses, entertainment expenses, business promotion expenses, share issue expenses written-off, underwriting commission on issue of shares written-off.

Exceptional Items

They are not defined in Schedule III. It has been defined in AS-5 on net profit or loss for the period, prior period items and changes in accounting policies.

Exceptional item is an income or expense that arises from transactions that are clearly distinct from ordinary activities of the business in types of financial statements.

Exceptional items, as examples will includes

(1) Reducing the value of inventories to net realisable value.

(ii) Disposal of fixed assets.

(iii) Disposal of long-term investments.

(iv) Legislative changes having retrospective application.

(v) Reversals of provisions.

Extraordinary Items

They are also not defined in Schedule III.

However, it has been defined in AS-5 on net profit or loss for the period, prior period items and changes in accounting policies.

Extraordinary Items are incomes or expenses that arise from events or transactions that are clearly distinct from ordinary activities of the enterprise and are not expected to recur frequently or regularly.

For Example – compensaton paid under voluntary retirement scheme.


Format of Cash Flow Statement

A Cash flow statement is a statement showing inflows (receipts) and outflows (payments) of cash and cash equivalents of the business during a particular period.

It is a statement showing the changes in the financial position of a business concern during different intervals

of time.

CASHFLOW STATEMENT (1)
CASHFLOW STATEMENT (2)
CASHFLOW STATEMENT (3)

(Note– most of the format I made on A4 document, so you can also print them)


Three activities at glance

Operating Activites

Cash flow from operating activities (CFO) indicates the amount of money a company brings in from its ongoing, regular business activities, such as manufacturing and selling goods or providing a service to customers.

It is the first section depicted on a company’s cash flow statement.

Cash flow from operating activities does not include long-term capital expenditures or investment revenue and expense.

CFO focuses only on the core business, and is also known as operating cash flow (OCF) or net cash from operating activities.

Investing Activities

Cash flow from investing activities is one of the sections on the cash flow statement that reports how much cash has been generated or spent from various investment-related activities in a specific period.

Investing activities include purchases of physical assets, investments in securities, or the sale of securities or assets.

Negative cash flow is often indicative of a company’s poor performance.

However, negative cash flow from investing activities might be due to significant amounts of cash being invested in the long-term health of the company, such as research and development.

If you want to invest in mutual funds then this mutual funds post can be a good read

Financing Activities

Cash flow from financing activities (CFF) is a section of a company’s cash flow statement, which shows the net flows of cash that are used to fund the company.

Financing activities include transactions involving debt, equity, and dividends in types of financial statements.

Cash flow from financing activities provides investors with insight into a company’s financial strength and how well a company’s capital structure is managed.


Basic things in Cash flow statement

Cash Flow

Cash Flows are are inflows and outflows of cash and cash equivalents which imply movement of cash in and out

from non-cash items.

Receipt of cash from a non-cash item is termed as cash inflow, while cash payment in respect of such items is termed as cash outflow.

Cash and Cash Equivalents

As per AS-3, cash comprises cash in hand and demand deposits with banks, and cash equivalents mean short-term highly liquid investments that are readily convertible into known amounts of cash and which are subject to an insignificant risk of changes in value.

For example- short-term marketable securities, which can be readily converted into cash, are treated as cash equivalents.

Non-Cash transactions

Those transactions in which flow (inflow or outflow) of cash and cash equivalents does not take place are called non-cash transactions.

Non-cash transactions are ignored while preparing cash flow statement because these do not involve cash.

For Example-

(a) Issue of equity shares or debentures against purchase of an asset.

(b) Issue of equity shares on conversion of convertible debentures.

(c) Charging of depreciation on a fixed tangible asset.

(d) Amortisation of a fixed intangible asset.

(e) Writing-off of a old fixed tangible asset.

(f) Declaration of final dividend on shares,


Your suggestions

While making this post I realised that in some places there are different things written which may confuse you.

But I tried my best to present you only that much stuff which is needed and that can get you good understand of all concepts.

Like I mentioned in the post these are three types of financial statements and two (statements of changes in equity and notes to accounts) are other two.

I suggest you to read the also if you want to get more knowledge but these three are most common and you won’t need them.

At last I just want to thank you for sticking with financebread this long.

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