What are Financial Stements?
Financial statements show you where the company’s or business money came from, where it went, and where it is now.
There are four main financial statements.
They are:
(1) balance sheets;
(2) income statements or Profit and Loss Statements;
(3) cash flow statements; and
(4) statements of shareholders’ equity.
Balance sheets show what a company or business owns and what it owes at a fixed point in time.
Income statements or Profit and Loss Statementsshow how much money a company or business has made and spent over a period of time.
Cash flow statements show the exchange of money between a company/business and the outside world also over a period of time.
The fourth financial statement, called a “statement of shareholders’ equity,” shows changes in the interests of the company’s shareholders or business owners over time.
Let’s look at each of the first two financial statements in more detail.
Balance Sheets
A balance sheet provides detailed information about the a company or business assets, liabilities and shareholders’ equity.
Assets are things that a company or business owns that have value. This typically means they can either be sold or used by the business to make products or provide services that can be sold. Assets include physical property, such as plant, trucks, equipment and inventory. It also includes things that can’t be touched ie intangibles but nevertheless exist and have value, such as trademarks and patents. Cash itself is an asset and so are investments a business makes.Debtors ( ie people who owe the business money) are also assets.
Liabilities are amounts of money that a business owes to others. This can include all kinds of obligations, like money borrowed from a bank to launch a new product, rent for use of a building, money owed to suppliers for materials, payroll a company owes to its employees, environmental cleanup costs, or taxes owed to the government. Liabilities also include obligations to provide goods or services to customers in the future.
Shareholder or Owners equity is sometimes called capital or net worth. It’s the money that would be left if a company or business sold all of its assets and paid off all of its liabilities. This leftover money belongs to the shareholders of the company , or the owners of the business.
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The following formula summarizes what a balance sheet shows:
A company’s assets have to equal, or “balance,” the sum of its liabilities and owners/shareholders’ equity. |
The business balance sheet is set up like the basic accounting equation shown above. On the left side of the balance sheet, companies list their assets. On the right side, they list their liabilities and shareholders’ equity. Sometimes balance sheets show assets at the top, followed by liabilities, with shareholders’ equity at the bottom.
Assets are generally listed based on how quickly they will be converted into cash. Current assets are things a company expects to convert to cash within one year. A good example is inventory. Most companies expect to sell their inventory for cash within one year. Noncurrent assets are things a company does not expect to convert to cash within one year or that would take longer than one year to sell. Noncurrent assets include fixed assets. Fixed assets are those assets used to operate the business but that are not products available for sale, such as trucks, office furniture and other property.
Liabilities are generally listed based on their due dates. Liabilities are said to be either current or long-term. Current liabilities are obligations a company expects to pay off within the year. Long-term liabilities are obligations due more than one year away.
Shareholders’/owners’ equity is the amount owners invested in the company’s stock plus or minus the company’s earnings or losses since inception. Sometimes companies distribute earnings, instead of retaining them. These distributions are called dividends.
A balance sheet shows a snapshot of a company’s assets, liabilities and owners/shareholders’ equity at the end of the reporting period. It does not show the flows into and out of the accounts during the period.
Income Statements
An income statement is a report that shows how much revenue a company earned over a specific time period (usually for a year or some portion of a year). An income statement also shows the costs and expenses associated with earning that revenue. The literal “bottom line” of the statement usually shows the company’s net earnings or losses. This tells you how much the company earned or lost over the period.
To understand how income statements are set up, think of them as a set of stairs. You start at the top with the total amount of sales made during the accounting period. Then you go down, one step at a time. At each step, you make a deduction for certain costs or other operating expenses associated with earning the revenue. At the bottom of the stairs, after deducting all of the expenses, you learn how much the company actually earned or lost during the accounting period. People often call this “the bottom line.”
At the top of the income statement is the total amount of money brought in from sales of products or services. This top line is often referred to as gross revenues or sales. It’s called “gross” because expenses have not been deducted from it yet. So the number is “gross” or unrefined.
The next line is money the company doesn’t expect to collect on certain sales. This could be due, for example, to sales discounts or merchandise returns.
When you subtract the returns and allowances from the gross revenues, you arrive at the company’s net revenues. It’s called “net” because, if you can imagine a net, these revenues are left in the net after the deductions for returns and allowances have come out.
Moving down the stairs from the net revenue line, there are several lines that represent various kinds of operating expenses. Although these lines can be reported in various orders, the next line after net revenues typically shows the costs of the sales. This number tells you the amount of money the company spent to produce the goods or services it sold during the accounting period.
The next line subtracts the costs of sales from the net revenues to arrive at a subtotal called “gross profit” or sometimes “gross margin.” It’s considered “gross” because there are certain expenses that haven’t been deducted from it yet.
The next section deals with operating expenses. These are expenses that go toward supporting a company’s operations for a given period – for example, salaries of administrative personnel and costs of researching new products. Marketing expenses are another example. Operating expenses are different from “costs of sales,” which were deducted above, because operating expenses cannot be linked directly to the production of the products or services being sold.
Depreciation is also deducted from gross profit. Depreciation takes into account the wear and tear on some assets, such as machinery, tools and furniture, which are used over the long term. Business’ spread the cost of these assets over the periods they are used. This process of spreading these costs is called depreciation or amortization. The “charge” for using these assets during the period is a fraction of the original cost of the assets.
After all operating expenses are deducted from gross profit, you arrive at operating profit before interest and income tax expenses. This is often called “income from operations.”
Next business must account for interest income and interest expense. Interest income is the money business make from keeping their cash in interest-bearing savings accounts, money market funds and the like. On the other hand, interest expense is the money companies paid in interest for money they borrow. Some income statements show interest income and interest expense separately. Some income statements combine the two numbers. The interest income and expense are then added or subtracted from the operating profits to arrive at operating profit before income tax.
Finally, income tax is deducted and you arrive at the bottom line: net profit or net losses. (Net profit is also called net income or net earnings.) This tells you how much the company actually earned or lost during the accounting period. Did the company make a profit or did it lose money?
How do we prepare your Financial Statements
Once the adjusting entries have been made or entered into a worksheet, the financial statements can be prepared using information from the ledger accounts. Because some of the financial statements use data from the other statements, the following is a logical order for their preparation:
- Income statement
- Statement of retained earnings
- Balance sheet
- Cash flow statement
Income Statement
The income statement reports revenues, expenses, and the resulting net income. It is prepared by transferring the following ledger account balances, taking into account any adjusting entries that have been or will be made:
- Revenue
- Expenses
- Capital gains or losses
Statement of Retained Earnings
The retained earnings statement shows the retained earnings at the beginning and end of the accounting period. It is prepared using the following information:
- Beginning retained earnings, obtained from the previous statement of retained earnings.
- Net income, obtained from the income statement
- Dividends ( if any) paid during the accounting period
Balance Sheet
The balance sheet reports the assets, liabilities, and shareholder equity of the company. It is constructed using the following information:
- Balances of all asset accounts such cash, accounts receivable, etc.
- Balances of all liability accounts such as accounts payable, notes, etc.
- Capital stock balance
- Retained earnings, obtained from the statement of retained earnings
All of the above information is given as a brief outline of what is a financial statement – every business is different and every business has a financial statement that contains information specific for that business – we at Astute know how important it is for you to understand your business and how you can use those figures and information to improve that “bottom line ” and grow your business – contact us to find out how we can help on (08) 9300 3240
