Consolidated Financial Statements
What it is:
Consolidated financial statements are the combined financial statements of a company and all of its subsidiaries, divisions or suborganizations.
How it works (Example):
Let's assume Company XYZ is a holding company that owns four other companies: Company A, Company B, Company C and Company D. Each of the five companies pays royalties and other fees to Company XYZ. At the end of the year, Company XYZ's income statement might reflect a large amount of royalties and fees and very few expenses (because these are recorded on the subsidiary income statements). Thus, an investor looking solely at Company XYZ's holding company could easily get a misleading view of the entity's performance. However, if Company XYZ consolidates its financial statements -- that is, it essentially "adds" the income statements, balance sheets and cash flow statements of XYZ and the four subsidiaries together -- the results give a better picture of the Company XYZ enterprise as a whole.
In the example below, notice how the holding company's assets are only $1 million, but the consolidated number shows that the entity as a whole controls $213 million in assets.
In the real world, Generally accepted accounting principles (GAAP) require companies to eliminate intercompany transactions from their consolidated statements (that is, they must exclude movements of cash, revenue, assets or liabilities from one entity to another) so as not to double count. Some examples include interest one subsidiary earns from a loan made to another subsidiary, "management fees" that a subsidiary pays the parent company and sales and purchases among subsidiaries.
Why it Matters:
Consolidated financial statements provide a comprehensive overview of a company's operations. Without them, investors would not have an idea of how well an enterprise as a whole is doing.
AAP dictates when and how statements should be consolidated and whether certain entities need to be consolidated. Thus, it is important to note that entities in which a company only owns a minority interest do not often need to be consolidated. For instance, if Company XYZ owned only 5% of Company A, it probably would not have to consolidate Company A's financial statements with its own.
Companies often break out their consolidated statements by division or subsidiary so investors can see the relative performance of each, but in many cases this is not required, especially if the company owns 100% of the division or subsidiary.