Encyclopedia of Financial Models II

Financial Statements

PAMELA P. DRAKE, PhD, CFA

J. Gray Ferguson Professor of Finance, College of Business, James Madison University

FRANK J. FABOZZI, PhD, CFA, CPA

Professor of Finance, EDHEC Business School

Abstract: Much of the financial data that is used in financial modeling is drawn from the company's financial statements. The four basic financial statements are the balance sheet, the income statement, the statement of cash flows, and the statement of shareholders' equity. It is important to understand these data so that the information conveyed by them is interpreted properly in financial modeling. The financial statements are created using several assumptions that affect how to use and interpret the financial data.

Financial statements are summaries of the operating, financing, and investment activities of a business. Financial statements should provide information useful to both investors and creditors in making credit, investment, and other business decisions. And this usefulness means that investors and creditors can use these statements to predict, compare, and evaluate the amount, timing, and uncertainty of future cash flows.1 In other words, financial statements provide the information needed to assess a company’s future earnings and, therefore, the cash flows expected to result from those earnings.

Information from financial statements is typically used in financial modeling for forecasting and valuation purposes. In this entry, we discuss the general principles ...