A company’s net profit rises from $536 thousand to $560 thousand in a year. Good news, right? Oddly enough, its earnings per share actually fall, its receivables balloon by almost 29%, and it still has to borrow money to buy new machinery.
That is exactly why the four types of financial statements need to be read together. A company’s financial statements consist of the income statement, the balance sheet (statement of financial position), the statement of changes in equity, and the cash flow statement. All four tell the story of the same company from different angles.
If you are opening these types of financial statements for the first time, they can feel like a language from another planet: rows of numbers and foreign-sounding terms everywhere. The easiest way to understand them is to picture your own household finances. Your salary minus monthly spending is the “income statement”. A list of your house, motorbike, savings, and home mortgage as of today is the “balance sheet”. A note on why your family’s net worth went up or down is the “statement of changes in equity”. And the money that actually moves in and out of your wallet and bank account is the “cash flow statement”.
Understanding the types of financial statements is useful well beyond accountants. Management can evaluate costs and investments, lenders can judge a company’s ability to repay, and investors get a far more sensible basis than buying a stock because everyone in the WhatsApp group is buying it (we have all been tempted, haven’t we?).
For practice, we will use an imaginary manufacturing company, “danieel.id/ Company”, built with reference to Principles of Managerial Finance (13th edition) by Gitman and Zutter. All figures are in thousands of US dollars ($000), compare 2019 with 2018, and are for learning only, not investment advice.
How Are the Four Types of Financial Statements Connected?
The four types of financial statements are connected through net profit: profit from the income statement adds to equity, the closing equity balance goes into the balance sheet, and the same net profit becomes the starting point for calculating operating cash flow.
Let’s follow the journey of profit. Part of net profit is paid out as dividends, and the rest adds to retained earnings, which then appear on the balance sheet. The cash flow statement prepared using the indirect method also starts its calculation from that very same net profit figure.
In Indonesia, this structure is governed by PSAK 201 Presentation of Financial Statements (the new number for PSAK 1), issued by the Indonesian Institute of Accountants (IAI), the local counterpart of IAS 1. To be fair, the standard also requires notes to the financial statements as part of a complete set, but this article focuses on the four main types of financial statements, because that is where the numbers tell their story:
| Statement | Question it answers | Key figure for danieel.id/ Company, 2019 |
|---|---|---|
| Income statement (period) | Profit or loss over the year? | Net profit $560 thousand |
| Balance sheet (one date) | What does it own and owe? | Total assets $11,025 thousand |
| Changes in equity (period) | Why did owners’ equity change? | Equity rose to $7,570 thousand |
| Cash flow (period) | Where did cash come from and go? | Cash up $246 thousand |
In other words, rising profit does not necessarily mean more cash, and growing assets are not always a good sign. Let’s take the types of financial statements apart one by one, starting with the statement people look at most often.
Income Statement: A Report Card for One Period
The income statement is the type of financial statement that shows a company’s performance over a given period, starting from revenue and subtracting various costs until we arrive at net profit. In a household, this is the “salary minus spending” calculation for the month.
The sequence goes like this: revenue minus cost of goods sold gives gross profit, minus operating expenses gives operating profit (EBIT), and after interest and taxes, we arrive at net profit.
In the danieel.id/ Company example, 2019 revenue reached $6,115 thousand, up about 12% from $5,476 thousand. However, cost of goods sold grew faster, by about 15%, from $3,776 thousand to $4,335 thousand. As a result, gross profit rose only about 5%, from $1,700 thousand to $1,780 thousand.
A quick review of the income statement
Because danieel.id/ Company’s cost of goods sold grew faster than its sales, its gross profit margin slipped from about 31% to 29%. The cause could be raw material prices, wages, or the company being unable to raise selling prices due to competition. One table is not enough to be sure, but this statement hands us the right questions to investigate.
The good news is that operating expenses rose only about 5%, slower than revenue. EBIT increased from $893 thousand to $935 thousand. After interest and taxes, net profit rose from $536 thousand to $560 thousand, or roughly 4.5%. As a rough picture, out of every $100 in sales, only about $9 is left as net profit, much like a small Indonesian corner shop (warung) keeping Rp9,000 out of every Rp100,000 in sales.
The interesting part is earnings per share (EPS). This figure actually fell from about $1.81 to $1.77 because the number of common shares increased from 280,000 to 300,000. The cake got bigger, but so did the number of people sharing it.
The details are covered in How to Read a Company’s Income Statement, while margins, ROA, ROE, and other measures are discussed in company financial ratios.
Balance Sheet or Statement of Financial Position
The balance sheet is the type of financial statement that takes a snapshot of a company’s position on a specific date: the assets it controls, its obligations to others, and the owners’ claim. If the income statement is a video of the whole year, the balance sheet is a photo taken on December 31. Its basic relationship is always in balance:
Assets = Liabilities + Equity
Current assets are expected to turn into cash within the normal operating cycle, while non-current assets such as land, buildings, and machinery support the business over the long term. Liabilities are likewise split into short-term and long-term. Equity is what remains for the owners after all obligations are deducted, much like a family’s “net worth” once every installment is paid off on paper.
danieel.id/ Company’s total assets reached $11,025 thousand in 2019, up about 14.4% from the previous year. Gross fixed assets increased by $1,207 thousand, with the biggest jump coming from machinery worth $978 thousand. This picture fits a manufacturer that is adding capacity or upgrading its production facilities.
A quick review of the balance sheet
danieel.id/ Company’s accounts receivable rose about 28.9%, from $714 thousand to $920 thousand, far faster than its roughly 12% growth in sales. Current assets did rise from $2,092 thousand to $2,487 thousand, but receivables racing ahead on their own deserve a little suspicion (politely, of course).
Here is the rough math: if we divide receivables by sales and multiply by 365 days, sales took about 55 days on average to be collected in 2019, up from about 48 days in 2018. Did credit sales increase, or did collections slow down? The balance sheet does not answer that, but it shows us where to start asking.
On the financing side, total liabilities rose $523 thousand and equity rose about $864 thousand, with net long-term debt up $419 thousand. In other words, the asset expansion was not funded from a single source. The current ratio stood at about 2.52 times in 2019, up from 2.36 times, while the debt-to-equity ratio was about 0.46 times. Keep in mind that ratios only become meaningful when compared with the company’s own history, the nature of its industry, and its peers.
A line-by-line walkthrough is available in How to Read a Company’s Balance Sheet the Easy Way.
Statement of Changes in Equity
The statement of changes in equity is the type of financial statement that bridges owners’ equity at the beginning and end of a period, so we know exactly why equity went up or down. Changes can come from profit or loss for the period, dividends, new share issues, share buybacks, or other comprehensive income.
danieel.id/ Company’s equity moved from $6,706 thousand at the start of 2019 to $7,570 thousand at year-end. Net profit added $560 thousand, while preferred and common stock dividends reduced it by $30 thousand and $156 thousand respectively. A new issue of common stock added $70 thousand to common stock and $420 thousand to additional paid-in capital.
A quick review of changes in equity
danieel.id/ Company’s retained earnings rose from $2,776 thousand to $3,150 thousand, exactly equal to net profit of $560 thousand minus total dividends of $186 thousand. This detail is often misunderstood: retained earnings are not a pile of cash sitting in the bank, because they have very likely “changed form” into inventory, machinery, or receivables.
The share issue added $490 thousand in capital. This information helps separate equity growth that comes from business performance from growth that comes from fresh capital injections. Both push equity up, but they mean very different things.
The full explanation is in How to Read the Statement of Changes in Equity, and the relationship between profit, assets, and equity can be explored further through DuPont Analysis for ROA and ROE.
Cash Flow Statement
The cash flow statement is the type of financial statement that explains changes in cash and cash equivalents over a period, grouped into operating, investing, and financing activities. This grouping follows the principles of IAS 7 Statement of Cash Flows, which Indonesia has adopted as PSAK 207 Statement of Cash Flows.
Why can profit and cash differ? Accounting uses the accrual basis: sales are recognized before customers pay, expenses are recognized before cash goes out, and depreciation reduces profit without any cash payment. That is why net profit needs to be “translated” into cash through adjustments for working capital and non-cash items. In a household, it is like counting your salary as received when it only lands in your account next week.
A quick review of the cash flow statement
danieel.id/ Company’s operating activities generated positive cash of $801 thousand, more than its net profit of $560 thousand. The calculation starts from net profit, adds back depreciation and amortization of $259 thousand, and then adjusts for changes in working capital. The $206 thousand increase in receivables reduced operating cash, while the $108 thousand increase in accounts payable added to it.
Investing activities used $1,251 thousand in cash, mainly to add $1,207 thousand in gross fixed assets. An outflow that large is not automatically bad because it matches the increase in machinery on the balance sheet; the real question is whether that investment will eventually lift sales and profit enough.
Financing activities generated $696 thousand in cash from additional long-term debt and the share issue, after repayments of obligations and dividends. Add the three together ($801 − $1,251 + $696) and cash and marketable securities rose by $246 thousand, exactly matching the change in the balance sheet from $716 thousand to $962 thousand. This small reconciliation proves that the four types of financial statements really do lock together.
A line-by-line look at cash flows is covered in How to Read a Company’s Cash Flow Statement.
Frequently Asked Questions
What are the main types of financial statements?
The main types of financial statements are four: the income statement, the balance sheet or statement of financial position, the statement of changes in equity, and the cash flow statement. Under Indonesia’s PSAK 201, a complete set of financial statements also includes notes that explain the details behind the numbers.
Which type of financial statement should I read first?
The income statement is the easiest to read first because it shows business results over a single period. Move on to the balance sheet to see the position of assets and debts, then check the cash flow statement to make sure profit really turns into cash.
Why can a profitable company run short of cash?
A profitable company can run short of cash because profit is recorded on an accrual basis, while cash only comes in when customers pay. Piling receivables, swelling inventory, or a large machinery investment can drain cash even when the income statement shows a profit.
Are retained earnings the same as a company’s cash?
Retained earnings are not the same as cash. They are accumulated profits that have not been distributed, and the money may already have been spent on machinery, inventory, or receivables. The company’s actual cash position appears in the cash line on the balance sheet and in the cash flow statement.
Conclusion: One Company, Four Points of View
In short, understanding the types of financial statements is not about memorizing definitions but about finding the connections between numbers. Are sales growing faster than costs, are assets financed in a healthy way, and most importantly, does the profit actually turn into cash?
In the danieel.id/ Company example, the business is growing and still generating positive operating cash flow. However, cost of goods sold rose faster than sales, receivables are taking longer to collect, and the machinery expansion required additional debt and share capital. That is not a verdict of good or bad, but a set of signals that only shows up when all the types of financial statements are read side by side.
Just like household finances, a big salary means little if installments keep piling up and your wallet is always empty by the 20th of the month. The same goes for companies: the four types of financial statements must be read together to get the whole story. The first step is simple: pick the annual report of a company you know, then compare the growth of its net profit with its operating cash flow.
After that, move on to calculating ratios, comparing trends and peers, and learning various stock valuation methods. Standards keep evolving too; IFRS 18 Presentation and Disclosure in Financial Statements replaces IAS 1 and applies to annual reporting periods beginning on or after 1 January 2027. So always check the latest standards when analyzing real reports.
Of the four statements we just covered, which one have you skipped most often when reading an annual report? I am curious to hear your answer in the comments.
Numbers never lie, but they only tell the full truth when we are willing to read all of them, not just the pleasant ones.
This post is also available in:
