The Three Financial Statements

Why this matters

Every number in the last module, from STU Corp's margins to the cash it spent on equipment, comes from its financial statements. They're a company's official scorecard, prepared under accounting rules and, for the annual report, checked by an outside auditor. Learning to read them is the single most useful skill for understanding a business. This module uses STU Corp's statements throughout.

Three statements, three questions

The SEC's guide to financial statements describes them as showing where a company's money came from, where it went, and where it is now. It lists four main statements: the balance sheet, the income statement, the cash flow statement, and the statement of shareholders' equity, which tracks changes in the owners' stake.¹ This module focuses on the first three.

A helpful comparison is your own finances. Your income statement would be this year's pay minus this year's spending. Your balance sheet would list what you own today, like savings and a car, and what you owe, like a car loan. Your cash flow statement would be your bank account's record of money in and money out. Two of them are like a video of a period; the balance sheet is a photo of one moment.

STU Corp's statements at a glance

Line item	This year	Last year
Revenue	400	350
Gross profit	200	170
Operating income	80	62
Net income	58	44

STU Corp is fictional. Amounts in $ millions.

Line item	End of this year	End of last year
Total assets	335	289
Total liabilities	145	148
Total shareholders' equity	190	141
Total liabilities and shareholders' equity	335	289

STU Corp is fictional. Amounts in $ millions.

Line item	This year	Last year
Cash from operating activities	84	66
Cash from investing activities	(40)	(35)
Cash from financing activities	(24)	(12)
Change in cash	20	19

STU Corp is fictional. Amounts in $ millions. Numbers in parentheses are subtracted.

Like real financial statements, these show the most recent year first. The next three lessons go through each statement line by line.

The balance sheet always balances

Everything a company owns, its assets, was paid for either with money it owes to others, its liabilities, or with the owners' money, called shareholders' equity. So the two sides must always be equal:¹

Assets = Liabilities + Shareholders' equity

$ millions	End of this year	End of last year
Total assets	335	289
Total liabilities	145	148
Shareholders' equity	190	141
Liabilities plus equity	145 + 190 = 335	148 + 141 = 289

Rearranged, the equation says shareholders' equity is what's left after subtracting everything owed from everything owned: $335 million − $145 million = $190 million. That's the owners' stake, measured by the accounting rules.

Where to find them

A company's annual report on Form 10-K includes its audited financial statements: the income statement, which is sometimes called the statement of earnings or the statement of operations, the balance sheet, the statement of cash flows, and the statement of stockholders' equity.² The notes that follow the statements explain the accounting choices behind the numbers, and the SEC's guide stresses how important it is to read them.¹

Key takeaways

• The income statement shows profit over a period. The balance sheet shows what's owned and owed at one moment. The cash flow statement shows cash in and out over a period.
• Assets always equal liabilities plus shareholders' equity.
• STU Corp had $335 million of assets, $145 million of liabilities, and $190 million of equity at the end of this year.
• The audited statements are in the annual report on Form 10-K, followed by notes worth reading.

Check your understanding

You want to know how much debt a company has right now. Which statement shows it?

1. The income statement.
2. The balance sheet.
3. The cash flow statement.

A company has $500 million of assets and $320 million of liabilities. What is its shareholders' equity?

1. $180 million
2. $820 million
3. It can't be worked out without the income statement.

What's next

The next lesson, The Income Statement, goes through STU Corp's income statement line by line, from revenue to earnings per share.