What are financial statements?

- [Instructor] Let's begin with an important question, and that is, what exactly are financial statements? Think of financial statements as a lab results for your company's financial health. Through reading financial statements, you'll be able to understand so many different financial metrics related to your company, such as how much you are generating in income or profits, as well as what you have in what we call assets, which we'll get to shortly. Or potentially what you owe to creditors, which we'll also talk about shortly. Anytime that you hear the term financial statements, they generally refer to these three financial statements. The profit and loss, which may also be called an income statement, the balance sheet, which may also be called the statement of financial position, and the statement of cash flows. We're going to do a deep dive into each of these financial statements shortly, but let's do a quick overview right now. The profit and loss tells you about the performance of your business. It showcases all of the details behind your income and all of the details behind your expenses. It also helps you understand profitability at multiple different levels. The balance sheet, on the other hand, tells you about the position of your business and it's separated by assets, liabilities, and owners equity. Now, if these terms are overwhelming to you, don't worry. We're going to do a full deep dive on each of these sections and the accounts that make up those sections. At a high level, assets are items of economic value that the business owns or substantially controls. Liabilities and owners equity are amounts that the business owes to others. Liabilities are owed to creditors of the business while owners equity are amounts owed to the owners of the business. Our third financial statement is the statement of cash flows. This financial statement tells you how your most important asset is moving, your cash. It's typically separated by these three sections. Cash from operating activities, cash from investing activities, and cash from financing activities. Each of these sections tells you a different story as to how exactly your cash is either increasing or decreasing from one period to another. Before we proceed, let's talk about one other important aspect with financial statements. We've so far talked about these three financial statements, the profit and loss, the balance sheet, and the statement of cash flows. The profit and loss showcases information on an incremental basis. That means whatever values we have in Q2 2024 in this example, are only related to activity that took place in Q2 2024. Now, that may sound very simple, but that's actually not the case when we get to the balance sheet. Instead, a balance sheet shows its values on a cumulative basis. So in this example, the values that we show in Q2 2023 are from a specific point in time. Any prior values will carried forward through this period along with any changes made in that period. For that reason, you may hear of a balance sheet as a snapshot of a company's financial health. It's in essence, a snapshot in a moment of time of where exactly the company is in relation to its assets, liabilities, and owners equity. The statement of cash flows behave similarly to the profit and loss in that all of the information that you see here is really shown on an incremental basis. So Q2 2023's values relate only to Q2 2023. As we'll soon see, the statement of cash flows is really just another way of looking at your balance sheet when prepared on the indirect method. Here, we in essence showcase the difference in every balance sheet account to get to our ending plug for our cash movements. Okay, we're getting a little bit ahead of ourselves. Let's now focus on a very important topic before we do our deep dive on the financial statements, and that is our accounting method with the two methods being the cash basis of accounting and the accrual basis of accounting.