1. Introduction to Financial Statements
This module provides an introduction to the three primary financial statements: income statement, balance sheet, and cash flow statement.
Author: Stu James
© 2015 Stu James and Management by the Numbers, Inc.

2. Financial Statements
Financial Statements
This tutorial will provide a brief introduction to the three most important financial statements:
Balance Sheet
Income Statement
Cash Flow Statement
The purpose of this tutorial is only to introduce the format and purpose of the three financial statements, as well as acquaint you with the various account categories within each statement.
There is a follow-up module for each statement that provides more information on how the statements are generated, though only at a superficial level.
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3. Financial Statements
Financial Statements
There are two primary reasons that companies generate financial statements:
To provide insights for managers and shareholders about the financial health of the company.
To fulfill the quarterly reporting requirement for publicly traded companies.
Now, let’s look at each statement individually, starting with the Balance Sheet.
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4. Introduction to the Balance Sheet
The Balance Sheet is one of the essential financial statements (reports) for a company and is a required filing for all public companies.
The Balance Sheet provides important information about the financial health of a company at a particular point in time – a “snapshot”. This information includes:
Assets (what the company owns)
Liabilities (what the company owes)
Shareholder’s Equity (what is left for
shareholders)
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5. Assets = Liabilities + Shareholder Equity
Sample Balance Sheet
Sample Balance Sheet
Here is a (very) simplified balance sheet for Apple, Inc. as of Sept 27, Apple’s balance sheet consists of three major categories. What else can we say?
First, note that
Assets = Liabilities + Shareholder Equity
($231B = $120B + $111B)
This must always be true!
Second, note that the figures are as of Sept 30, 2013, a particular moment in time.
Apple, Inc.
As of Sept 27, 2014
$Millions
Assets
231,839
Liabilities
120,292
Shareholder Equity
111,547
We can also say that Apple’s assets (what it owns) far outweighs its liabilities (what it owes).
Now let’s look at these three parts of the balance sheet in more detail.
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6. Assets Let’s look at Apple’s assets in more detail.
First, note that assets are divided into current assets and non-current assets. Examples of current assets include cash, CDs, marketable securities (stocks and bonds), accounts receivable (payments owed to a company by customers), inventory, and pre-paid expenses (when a company pays a bill in advance).
Apple, Inc. Assets
$Millions
Cash and Cash Equivalents
13,844
Short-Term Investments
11,233
Receivables
31,537
Inventory
2,111
Other Current Assets
9,806
Total Current Assets
68,531
Long Term Investments
130,162
Plant, Property and Equipment
20,624
Intangible Assets
8,758
Other Assets
3,764
Total Assets
231,839
Definition: Current Assets are those assets which can reasonably be expected to be converted into cash within one year.
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7. Assets
Assets
Now let’s consider non-current assets. Examples of non-current assets include buildings, vehicles, operating plants, equipment, office furniture, and intangible assets. Intangible assets would include intellectual property and goodwill. Most long-term assets are depreciated or amortized over time. Depreciation and amortization represent how a long-term asset gets used up over time.
Apple, Inc. Assets
$Millions
Cash and Cash Equivalents
13,844
Short-Term Investments
11,233
Receivables
31,537
Inventory
2,111
Other Current Assets
9,806
Total Current Assets
68,531
Long Term Investments
130,162
Plant, Property and Equipment
20,624
Intangible Assets
8,758
Other Assets
3,764
Total Assets
231,839
Definition: Non-Current Assets are longer-term assets that are not expected to be liquidated. These are depreciated or amortized over time.
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8. Liabilities Let’s look at Apple’s liabilities in more detail:
Just like current assets, current liabilities are those debts that are expected to be paid during the coming year. Examples of current liabilities include accounts payable (what a company owes vendors for products or services purchased), taxes payable, debt of less than one year or debt coming due within a year (bonds that mature in the coming year).
Apple, Inc. Liabilities
$Millions
Accounts Payable
48,649
Short-Term Debt
6,308
Other Current Liabilities
8,491
Total Current Liabilities
63,448
Long Term Debt
28,987
Other Liabilities
27,857
Total Liabilities
120,292
Definition: Current Liabilities are those debts which are expected to be paid within the coming year.
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9. Liabilities Now let’s consider Apple’s long-term liabilities:
Apple, Inc. Liabilities
$Millions
Accounts Payable
48,649
Short-Term Debt
6,308
Other Current Liabilities
8,491
Total Current Liabilities
63,448
Long Term Debt
28,987
Other Liabilities
27,857
Total Liabilities
120,292
Long-term liabilities include items such as long-term bonds with a maturity date over a year, real estate loans, and other long-term bank loans.
Definition: Long-Term Liabilities are those debts which are expected to be repaid more than a year in the future.
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10. Shareholder Equity Now let’s look at Apple’s Shareholder Equity:
Shareholder equity includes retained earnings (from the Income Statement), Capital Surplus (any initial or subsequent investment in the company by shareholders beyond the par value of the stock). In addition, the par value of any preferred or common stock would be listed here separately.
Apple Shareholder Equity
$Millions
Retained Earnings
87,152
Capital Surplus
23,313
Other Shareholder Equity
1,082
Total Shareholder Equity
111,547
Insight
Equity accounts represent the (residual) value of the company (or, assets minus liabilities)
Definition: Shareholder Equity accounts are the residual accounts – what would be left for the shareholders after all liabilities are paid.
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11. Introduction to the Income Statement
The income statement is one of the essential financial statements (reports) for a company and is a required filing for all public companies.
The income statement provides important information about the financial health of a company over a certain period of time (usually a year or a quarter). This information includes:
Revenues (sales of product/services)
Expenses (costs of doing business)
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12. Sample Income Statement
Here is a (very) simplified income statement for Apple, Inc. for the year ending Sept 27, What can we say about this income statement?
Apple, Inc.
Year ending Sept 27, 2014
$millions
Revenues
182,795
Expenses
143,285
Net Income
39,510
First, note that
Revenues – Expenses
= Net Income
(182,795 – 143,285 = 39,510)
Second, note that the reporting period is for 12 months (Sept Sept 27, 2014)
We can also say that Apple is a profitable company during this period, because revenues exceed total expenses, leaving net income of $39,510 million. Now let’s look at these areas in more detail.
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13. Total Revenue
Total Revenue
Total Revenue is the combined total for all sales in a period.
Apple, Inc. Inc. Statement
$Millions
Total Revenue
182,795
Cost of Revenue
112,258
Gross Profit
70,537
Research and Development
6,041
Selling, General and Admin.
11,993
Operating Income or Loss
52,503
Interest Expense
Net Non-Recurring Events
980
Income Taxes
13,973
Net Income
39,510
Total revenue is all sales from products and services for the company (aka the “top line” of the business – as opposed to the “bottom line” or net income.). Publicly, only a single line will be shown for revenue, but internally to the company, revenue will be reported in a very detailed fashion – broken out by product line, geographic region, etc.
Definition: Total Revenue = Net sales of all products and services.
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14. Gross Profit Subtracting the Cost of Revenue leaves Gross Profit.
Gross Profit is what is left after subtracting cost of revenue. Cost of Revenue (or Cost of Sales) includes any direct expenses (cost of goods / services sold) associated with revenues. Gross profit (as a percent) varies widely by business type. Both gross profit and cost of revenue are often expressed as % of total revenue for comparisons.
Apple, Inc. Inc. Statement
$Millions
Total Revenue
182,795
Cost of Revenue
112,258
Gross Profit
70,537
Research and Development
6,041
Selling, General and Admin.
11,993
Operating Income or Loss
52,503
Interest Expense
Net Non-Recurring Events
980
Income Taxes
13,973
Net Income
39,510
Definition: Gross Profit = Total Revenue – Cost of Revenue
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15. Operating Income
Operating Income
Now let’s look at the next section of the Income Statement.
Operating Income (or EBIT – Earnings before Interest and Taxes) represents a company's earnings from its normal operations (not including interest expense, taxes and one-time costs). It is calculated by subtracting other on-going operating expenses from Gross Profit. Operating income is often used by analysts rather than net income as a measure of profitability.
Apple, Inc. Inc. Statement
$Millions
Total Revenue
182,795
Cost of Revenue
112,258
Gross Profit
70,537
Research and Development
6,041
Selling, General and Admin.
11,993
Operating Income or Loss
52,503
Interest Expense
Net Non-Recurring Events
980
Income Taxes
13,973
Net Income
39,510
Definition: Operating Income = Gross Profit – (SGA + R&D)
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16. Net Income Net Income is the “bottom line” of the Income Statement
To calculate Net Income, or the “bottom line” of a business, we subtract remaining expenses from operating income. For various reasons, analysts separate out interest expense (financing costs), net non-recurring events (special situations) and income taxes from the normal operating costs of a business.
Apple, Inc. Inc. Statement
$Millions
Total Revenue
182,795
Cost of Revenue
112,258
Gross Profit
70,537
Research and Development
6,041
Selling, General and Admin.
11,993
Operating Income or Loss
52,503
Interest Expense
Net Non-Recurring Events
980
Income Taxes
13,973
Net Income
39,510
Definition:
Net Income = Oper. Income - Interest - Taxes - Non Recurring Items
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17. Introduction to the Cash Flow Statement
The cash flow statement is the third essential financial statement for a company and is a required filing for all public companies.
The cash flow statement provides important information about the sources and uses of cash:
From operating activities
From investing activities
From financing activities
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18. Sample Cash Flow Statement
Here is a (very) simplified cash flow statement for Apple, Inc. for the year ending Sept 27, What can we say about this cash flow statement?
Apple Computer, Inc.
Year ending Sept 27, 2014
$millions
Net Cash Flow-Operating
$59,713
Net Cash Flow-Investing
($22,579)
Net Cash Flow-Financing
($37,549)
Net Cash Flow
($415)
First, note that there are 3 general areas of cash flow: operations, investing, and financing, and, at least at Apple, all of their positive cash flow came from operations. A positive cash flow from operations is generally a sign of a healthy company.
Now let’s look at these three areas of cash flow in more detail.
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19. Cash Flow from Operating Activities
Let’s start with cash flow from operating activities (CFO).
This category of cash flow starts with net income and then makes any adjustments necessary to get a more complete picture of how much cash was generated (or lost) from operating activities. This would include adding back depreciation and other non-cash expense, and adjusting for any changes in accounts receivable, liabilities, and inventories.
Apple, Inc. Cash Flow Statement (Operating Activities)
$Millions
Net Income
39,510
Depreciation
7,946
Adjustments to Net Income
5,210
+ Decrease in Accts Receivable
(6,452)
+ Increase in Liabilities
13,408
+ Decrease in Inventories
(76)
Other Changes in Operating Act.
167
Total Cash Flow from Operating Activities
59,713
Insight
In this example, inventories increased by $76M, a use of cash.
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20. Cash Flow from Investing Activities
Next is cash flow from investing activities (CFI).
This category of cash flow addresses more long-term asset or liability decisions, which would include purchase or sale of long-term assets (land, building, equipment, securities, etc.), long-term borrowing arrangements with suppliers or customers, and transactions relating to mergers and acquisitions.
Apple, Inc. Cash Flow Statement
(Investing Activities)
$Millions
Capital Expenditures
(9,571)
Investments
(9,017)
Other Cash Flows from Investing
(3,991)
Total Cash Flow from Investing Activities
(22,579)
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21. Cash Flow from Investing Activities
Cash Flow from Financing Activities
Cash Flow from Investing Activities
Next is cash flow from financing activities (CFF).
Apple, Inc. Cash Flow Statement
(Financing Activities)
$Millions
Dividends Paid
(11,126)
Sale / Purchase of Stock
(44,270)
Net Borrowings
18,266
Other Cash Flows from Financing
(1,158)
Total Cash Flow from Financing Activities
(37,549)
This category of cash flow captures the company’s own financial choices such as selling or repurchasing their own stock and/or bonds, paying dividends (and associated taxes), and repayment of debt principal, including capital leases.
Insight
This section of Apple’s Cash Flow Statement is rather unique. Why would they be borrowing funds and repurchasing stock at the same time, especially when operations are generating so much cash? See if you can search articles online to find out why.
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22. Further Reference
Further Reference
MBTN Balance Sheet, Income Statement and Cash Flow Statement Modules which review the basic information provided here, but adds examples of how various accounting transactions impact each statement and introduce debits and credits.
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