What Are the 3 Major Financial Statements?

The 3 major financial statements include income sheets (profit and loss statements), balance sheets, and cash flow statements. We call them a three-way forecast or a three-statement model. In fact, they use assumptions, drivers, and specific business data to create one consolidated forecast that projects all three. Moreover, these 3 major financial statements form the backbone of any detailed financial analysis.

How the 3 Major Financial Statements Are Used in Financial Modeling

Financial models are spreadsheets that forecast a business’s future performance. Analysts build these models by using data from the 3 major financial statements. They start with a three-statement model that offers granular forecasts covering revenue growth, profitability, capital needs, cash burn, and metrics like the Rule of 40.

Furthermore, financial modeling software simplifies this process. It helps you create accurate financial forecasts without sifting through endless data, all by harnessing the power of the 3 major financial statements.

Income Statement

An income statement lists a company’s revenues and expenses over a set period, such as a quarter or a year. It shows whether the business makes a profit or suffers a loss by highlighting net income. Because the income statement ends with net income, we also call it the “profit and loss statement.” In our analysis, the income statement plays a critical role among the 3 major financial statements.

The income statement usually follows this format:

  • Revenue: The total money earned from sales.
  • Cost of Goods Sold (COGS): The direct cost of producing the goods or services.
  • Gross Profit: The profit after subtracting COGS from revenue.
  • Operating Expenses: The costs required to run day-to-day operations.
  • Operating Income: Earnings before interest and taxes (EBIT) after deducting operating expenses.
  • Net Profit: The final profit after subtracting all expenses from revenue.
  • Selling, General, and Administrative Expenses: The overall costs of running the business.
  • Pre-tax Income: Earnings before taxes.
  • Taxes: The total amount paid in taxes.

Additionally, most income statements calculate EPS (earnings per share) by dividing net income by the number of outstanding shares. This detailed report helps you understand a company’s financial stability, which is a key aspect of the 3 major financial statements.

Balance Sheet

A balance sheet shows a company’s assets, liabilities, and shareholders’ equity at a specific moment. It tells you what the company owns and what it owes. To balance this sheet, a company must ensure that its assets equal its liabilities plus shareholders’ equity. In our discussion of the 3 major financial statements, the balance sheet holds a crucial position.

Key elements include:

  • Assets: Resources with economic value that the company owns.
  • Liabilities: Debts and obligations such as loans, credit card debt, or accrued expenses.
  • Shareholders’ Equity: The money that would go to shareholders if the company liquidated its assets and settled all debts.

Moreover, pairing the balance sheet with the income statement helps you determine the cash or investment needed to support reported sales and gross profit. You should also review past balance sheets to assess overall financial strength. This practice further emphasizes the importance of the 3 major financial statements.

Cash Flow Statement

The cash flow statement tracks cash inflows and outflows over a period. It shows changes in cash and provides the starting and ending cash balances. This statement captures cash generated or used in three primary areas: operating activities, investing activities, and financing activities. The net cash flow equals the sum of these segments, making this statement essential among the 3 major financial statements.

Having an in-depth view of cash movement is crucial, so the cash flow statement remains a vital tool for determining a company’s financial health.

Cash Flow from Operations

Cash flow from operations details the money a company generates from its normal business activities. It appears first on the cash flow statement. You can calculate this cash flow in two ways:

  • Direct Method:
    The company records every cash transaction. This method shows cash inflows and outflows directly during the period.
  • Indirect Method:
    The process starts with net income on an accrual basis and adjusts for non-cash transactions and changes in balance sheet accounts. Both methods yield the same final number, which highlights how the 3 major financial statements interrelate.

Cash Flow from Investing

Cash flow from investing tracks cash spent or earned from investment-related activities within a period. Although negative cash flow from investing might seem alarming, it often signals future benefits from these investments. For instance, any change in the property, plant, and equipment (PPE) line on the balance sheet counts as an investing activity. Moreover, capital expenditures (CapEx) indicate that the company invests in its future operations. These aspects further underscore the role of the 3 major financial statements.

How the 3 Major Financial Statements Are Linked

The income statement, balance sheet, and cash flow statement connect to create a unified financial model. Here are some examples that illustrate how the 3 major financial statements link together:

  • Net Income:
    Net income ends the income statement and then starts the operating section of the cash flow statement. It also flows into the balance sheet through retained earnings. This simple linkage illustrates the influence of the 3 major financial statements on one another.
  • Depreciation:
    Depreciation appears in all three documents. The income statement treats it as an operating expense. Then, the cash flow statement adds it back as a non-cash expense. Finally, the balance sheet shows its effect on long-term assets. These actions keep the 3 major financial statements consistent.
  • Working Capital:
    Net working capital equals the difference between current assets and liabilities. Changes in working capital adjust the cash flow statement to reflect actual cash movements. These changes also affect the income statement, thereby linking all the major financial statements.
  • Financing Activities:
    When a company issues debt, interest expense shows up on the income statement and the principal balance appears on the balance sheet. Changes in these items then appear on the cash flow statement. This process further connects the major financial statements.
  • Cash Balance:
    After adding cash from operations, investing, and financing, you determine the current period’s closing cash balance on the balance sheet. This step confirms that the major financial statements work together seamlessly.

Conclusion: Understand the 3 Major Financial Statements

The 3 major financial statements—the income statement, balance sheet, and cash flow statement—combine to create a clear picture of a company’s financial condition. They offer invaluable insights to stakeholders who assess a company’s financial health and stability.

In addition, each document plays its part in painting a detailed financial narrative. This narrative explains revenue trends, profitability, investment needs, and cash management. By embracing the insights from the major financial statements, businesses and investors can make well-informed decisions based on a holistic view of financial performance.