The financial statement
Let's define the items found in the financial statements. The first primary financial statement is the balance sheet. A balance sheet is a listing of a company's valuable resources, its assets. An asset is defined as a tangible thing, or an intangible right that a company owns or controls and that's expected to generate benefits in the future. For example, land a company owns is an asset because in the future that land can be sold, generating a benefit in the form of cash received. Or the land can be used in the business, providing a benefit in the form of the location of business operations.
A balance sheet also shows the three general sources that companies use to get money to buy assets. First they can borrow it. Now if you borrow money, of course you have to pay it back. This obligation to repay an amount borrowed is called a liability. The second source for money is the owners or shareholders that can take money from their private savings and invest it in the business. And the third source is that the company can generate profits, which belong to the owners that are then kept in the business to buy more assets.
Together, these two sources of financing, owner-direct investment and retained profits are called equity. Equity is the amount of total financing provided by the owners. The fundamental difference between liabilities and equity is that liability amounts must be repaid to the lenders, whereas equity amounts do not have to be repaid. If owners repay equity amounts, they are reclaiming some of their investment funds and voluntarily shrinking the size of their investment in their business. Assets, liabilities and equity, those are the items found in the balance sheet.
The second primary financial statement is the income statement. An income statement is a report telling how much money a company made during the month or the quarter or the year, whatever period is covered by the income statement. Now the income statement contains revenues and expenses.
The revenue amount is the amount of assets generated through business operations. In 2018, Walmart generated over $500 billion in assets by selling stuff to you and to me. Now the expense amount is the amount of assets consumed in doing business operations. During 2018, Walmart consumed $385 billion in paying suppliers for the inventory items sold to you and me. Now the difference between revenues and expenses is called net income. Hopefully this difference is positive, meaning that the company's business operations have generated more assets than they've consumed.
The third primary financial statement is the statement of cash flows or cash flow statement, which is a report of a company's cash receipts and cash payments, separated into three categories, operating, investing, and financing. Operating cash flows are the things that companies do every day, collecting cash from customers, paying employees and so forth. Investing cash flows are investments in the productive capacity of the business. Buying more buildings and trucks and land and so forth. Now financing activities involve getting the money to buy the stuff that I need through borrowing and paying dividends to shareholders.
All right, so those are the three primary financial statements. The balance sheet, the income statement, and the statement of cash flows. The balance sheet contains assets, liabilities, and equity. The income statement contains revenues and expenses, with the difference labeled net income. And the statement of cash flows contains cash in and cash out from operating, investing, and financing activities. So now of the three primary financial statements, which is your favorite one? Now that's a tough question, I'm going to have to think about that.