Financial statements generally consist of three documents: income statement, balance sheet, and cash flow statement.
Income Statement: This is a financial summary for a period of time that compares inward flows (revenues) and outward flows (expenses). The difference between the two is net income (profit). Some expenses are not associated with cash disbursements, such as depreciation of equipment.
Balance Sheet: This is a statement of a business’s financial condition at a distinct point in time. It summarizes what is owned (assets) and what is owed (liabilities). The difference between the two is net worth. For every balance sheet, the following equation applies:
TOTAL ASSETS = LIABILITIES + NET WORTH
Cash Flow Statements: A cash flow statement is intuitively the easiest to understand. It is an accounting of all the cash coming into the business over a defined period of time and all the cash that went out of the business for the same period of time. A checkbook register is, in a sense, a cash flow statement. Some cash outflows are not accrual expenses, such as inventory purchased for resale. The inventory purchased is a conversion of one asset (cash) into another asset (inventory). It is not expensed as a "cost of goods sold" until it is sold. The purchase of equipment is a cash disbursement that also represents the conversion of one asset (cash) to another asset (equipment). The equipment is used up over time, and this non-cash expense is accounted for as depreciation expense.
