Table of Contents

Defining Financial Statements Balance Sheet Types of Balance Sheet Standard Format of a Balance Sheet Sample Balance Sheet Income Statement Usefulness and limitations of Income Statement Items on an Income Statement !perating Section "on#!perating Section %eneral format of an Income Statement Statement of &etained 'arnings )ash flo* Statement )ash flo* -cti.ities Sample cash flo* statement /urpose of financial statements %o.ernment financial statements -udit and legal implications Standards and regulations Inclusion in annual reports $ $ ( +, ++ ++ +2 +3 +3 +4 +5 2 2 3 4 5 6 6

Financial statements
These are the formal records of a business' financial activities. In British English, including United Kingdom company la , financial statements are often referred to as accounts, although the term financial statements are also used, particularly by accountants. !inancial statements give us a bird vie of a business' financial condition in both short and long term.

"ll the relevant financial information of a business enterprise presented in a structured manner and in a form easy to understand, is called the financial statements. There are four basic financial statements.

Balance sheet Income statement Statement of retained earnings Statement of cash flows Purpose of financial statements

Balance sheet
In financial accounting, a balance sheet or statement of financial position is a summary of a person's or organi#ation's balances. "ssets, liabilities and o nership e$uity are listed as of a specific date, such as the end of its financial year. " balance sheet is often described as a snapshot of a company's financial condition. %f the four basic financial statements, the balance sheet is the only statement hich applies to a single point in time. " company balance sheet has three parts& assets, liabilities and o nership e$uity. The main categories of assets are usually listed first and are follo ed by the liabilities. The difference bet een the assets and

the liabilities is 'no n as e$uity or the net assets or the net

orth of the company and according to the

accounting e$uation, net orth must e$ual assets minus liabilities. "nother ay to loo' at the same e$uation is that assets e$uals liabilities plus o ner's e$uity. (oo'ing at the e$uation in this ay sho s ho assets ere financed& either by borro ing money )liability* or by ith assets in one using the o ner's money )o ner's e$uity*. Balance sheets are usually presented

section and liabilities and net orth in the other section ith the t o sections +balancing.+ " business operating entirely in cash can measure its profits by ithdra ing the entire ban' balance at

the end of the period, plus any cash in hand. ,o ever, many businesses are not paid immediately- they build up inventories of goods and they ac$uire buildings and e$uipment. In other ords& businesses have assets and so they can not, even if they ithdra ant to, immediately turn these into cash at the end of each ords businesses also period. %ften, these businesses o e money to suppliers and to ta. authorities, and the proprietors do not all their original capital and profits at the end of each period. In other have liabilities.

Types of Balance Sheet

/ersonal balance sheet U0 small business balance sheet /ublic Business Entities balance sheet structure

Format of a Standard Balance Sheet.

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ASSETS

current assets 1 cash in the ban' 1 petty cash 2 net cash )by totalling the previous three items*inventory 1 accounts receivable 1 net cash 2 total current assets fi.ed assets 1 land 1 buildings 3 depreciation 2 net land and buildings e$uipment 3 depreciation 2 net e$uipment total assets

LIABILITIES

accounts payable 1 ages payable 1 ta.es payable 2 total current liabilities long term loans 1 morgage 2 total long term liabilities total liabilities

EQUITY

o ners e$uity 1 o ners dra s 1 retained earnings 1 current earnings 2 total earnings total e$uity

C%4/"56 5"4E I5 B(%CK (ETTE70

Balance 0heet 8ecember 9:, ;<== "ssets Cash "ccounts 7eceivable Inventory /repaid Insurance (and Building E$uipments Total "ssets ? ..,... ..,... ..,... ..,... ..,... ..,... ..,... ? ..,... % ner>s E$uity /erson>s Capital ..,... (iabilities and % ner>s E$uity (iabilities 5otes /ayable "ccounts /ayables Total (iabilities ? ..,... ..,... ..,... ..,...

Total (iabilities and % ner>s E$uity ? ..,...

"t the end of your balance sheet, if ASSETS = LIABILITIES + EQUITY, then you've done it properly. Congratulations@

Income statement
Income statement, also called profit and loss statement )/A(*, is a company's financial statement that indicates ho the revenue )money received from the sale of products and services before e.penses are ta'en out, also 'no n as the +top line+* is transformed into the net income )the result after all revenues and e.penses have been accounted for, also 'no n as the +bottom line+*. The purpose of the income statement is to sho managers and investors hether the company made or lost money during the period being reported. The important thing to remember about an income statement is that it represents a period of time. This contrasts ith the balance sheet, hich represents a single moment in time. Charitable organi#ations that are re$uired to publish financial statements do not produce an income statement. Instead, they produce a similar statement that reflects funding sources compared against program e.penses, administrative costs, and other operating commitments.

Usefulness and limitations of income statement

Income statements should help investors and creditors determine the past performance of the enterprise, predict future performance, and assess the capability of generating future cash flo s. ,o ever, information of an income statement has several limitations&

Items that might be relevant but cannot be reliably measured are not reported )e.g. brand recognition and loyalty*. 0ome numbers depend on accounting methods used )e.g. using !I!% or (I!% accounting to measure inventory level*.

0ome numbers depend on Budgments and estimates )e.g. depreciation e.pense depends on estimated useful life and salvage value*

Items on income statement Operating section

Revenue 3 Cash inflo s or other enhancements of assets of an entity during a period from delivering or producing goods, rendering services, or other activities that constitute the entity's ongoing maBor operations. Usually presented as sales minus sales discounts, returns, and allo ances.

Expenses 3 Cash outflo s or other using3up of assets or incurrence of liabilities during a period from delivering or producing goods, rendering services, or carrying out other activities that constitute the entity's ongoing maBor operations.
o

Ceneral and administrative e.penses )C A "* 3 represent e.penses to manage the business )officer salaries, legal and professional fees, utilities, insurance, depreciation of office building and e$uipment, office rents, office supplies*

0elling e.penses 3 represent e.penses needed to sell products )e.g., sales salaries, commissions and travel e.penses, advertising, freight, shipping, depreciation of sales store buildings and e$uipment*

0elling Ceneral and "dministrative e.penses )0CA" or 0C"* 3 consist of the combined payroll costs )salaries, commissions, and travel e.penses of e.ecutives, sales people and employees*, and advertising e.penses a company incurs. 0C" is usually understood as a maBor portion of non3production related costs, opposing production related costs such as ra material and )direct* labour

o o

7 A 8 e.penses 3 represent e.penses included in research and development 8epreciation 3 is the charge for a specific period )i.e. year, accounting period* respect to fi.ed assets that have been capitalised on the balance sheet. ith

Non-operatin section

!ther revenues or ains 3 revenues and gains from other than primary business activities )e.g. rent, patents*. It also includes unusual gains and losses that are either unusual or infre$uent, but not both )e.g. sale of securities or fi.ed assets*

!ther expenses or losses 3 e.penses or losses not related to primary business operations.

Following is the general format of income statement

- INCOME STATEMENT BOND LLC For the year ended DECEMBER 31 2007 $ Re en!e" #ROSS $ROFIT %&n'(!d&n) renta( &n'o*e+ E01en"e"2 AD3ERTISIN# BAN4 5 CREDIT CARD FEES BOO44EE$IN# EM$LO7EES ENTERTAINMENT INS9RANCE LE#AL 5 $ROFESSIONAL SER3ICES LICENSES $RINTIN#/ $OSTA#E 5 STATIONER7 RENT RENTAL MORT#A#ES AND FEES 9TILITIES TOTAL E:$ENSES NET INCOME ./300 1,, 3/360 88/000 6/660 760 1/676 .32 320 13/000 7,/,00 ,-1 -------%1-,/612+ -------301/886 ;;;;;;;; $ ,-./3-7 --------

Statement of retained earnin s

The Statement of Retained Earnin s )also 'no n as E"uity Statement, Statement of !#ner$s E"uity for a single proprietorship, Statement of %artner$s E"uity for partnership, and Statement of Retained Earnin s and Stoc&holders$ E"uity for corporation* is one of the basic financial statements as per Cenerally "ccepted "ccounting /rinciples, and it e.plains the changes in a company's retained earnings over the reporting period. It brea's do n changes affecting the account, such as profits or losses from operations, dividends paid, and any other items charged or credited to retained earnings. " retained earnings statement is re$uired by Cenerally "ccepted "ccounting /rinciples )C""/* henever comparative balance sheets and income statements are presented. It may appear in the balance sheet, in a combined income statement and changes in retained earnings statement, or as a separate schedule. Therefore, the statement of retained earnings uses information from the income statement and provides information to the balance sheet. 7etained earnings are part of the balance sheet )another basic financial statement* under +stoc'holders e$uity,+ and is mostly affected by net income earned during a period of time by the company less any dividends paid to the company's o ners D stoc'holders. The retained earnings account on the balance sheet is said to represent an +accumulation of earnings+ since net profits and losses are addedDsubtracted from the account from period to period. The general e$uation can be e.pressed as follo ing& Ending 7etained Earnings 2 Beginning 7etained Earnings 3 Investments 3 8ividends /aid 1 5et Income

'ash flo# statement

In financial accounting, a cash flo# statement or statement of cash flo#s is a financial statement that sho s a company's flo of cash. The money coming into the business is called cash inflo , and money changes in balance sheet going out from the business is called cash outflo . The statement sho s ho

and income accounts affect cash and cash e$uivalents, and brea's the analysis do n to operatin , investin , and financin activities. "s an analytical tool, the statement of cash flo s is useful in determining the short3term viability of a company, particularly its ability to pay bills. International "ccounting 0tandard E )I"0 E* is the International "ccounting 0tandard that deals statements. /eople and groups interested in cash flo statements include&

ith cash flo

"ccounting personnel,

ho need to 'no

hether the organi#ation

ill be able to cover payroll

and other immediate e.penses

/otential lenders or creditors, ho ant a clear picture of a company's ability to repay /otential investors, ho need to Budge hether the company is financially sound /otential employees or contractors, afford compensation ho need to 'no hether the company ill be able to

Purpose
The cash flo statement as previously 'no n as the statement of chan es in financial position or

flo# of funds statement. The cash flo statement reflects a firm's li$uidity or solvency. The balance sheet is a snapshot of a firm's financial resources and obligations at a single point in time, and the income statement summari#es a firm's financial transactions over an interval of time. These t o financial statements reflect the accrual basis accounting used by firms to match revenues ith the e.penses associated ith generating those revenues. The cash flo statement includes only inflo s and outflo s of cash and cash e$uivalents- it e.cludes transactions that do not directly affect cash receipts and payments. These noncash transactions include depreciation or rite3offs on bad debts to name a fe . The cash flo statement is a cash basis report on three types of financial activities& operating activities, investing activities, and financing activities. 5oncash activities are usually reported in footnotes.
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The cash flo statement is intended to :. provide information on a firm's li$uidity and solvency and its ability to change cash flo s in future circumstances ;. provide additional information for evaluating changes in assets, liabilities and e$uity 9. improve the comparability of different firms' operating performance by eliminating the effects of different accounting methods F. indicate the amount, timing and probability of future cash flo s The cash flo allocations, statement has been adopted as a standard financial statement because it eliminates hich might be derived from different accounting methods, such as various timeframes for

depreciating fi.ed assets.

Cash flow activities

The cash flo statement is partitioned into three segments, namely& cash flo resulting from operating activities, cash flo resulting from investing activities, and cash flo resulting from financing activities.

Sample cash flow statement using the direct method

'ash flo#s from operatin activities Cash receipts from customers Cash paid to suppliers and employees Cash generated from operations )sum* Interest paid Income ta.es paid 5et cash flo s from operating activities 'ash flo#s from investin activities /roceeds from the sale of e$uipment 8ividends received 5et cash flo s from investing activities 'ash flo#s from financin activities 8ividends paid 5et cash flo s used in financing activities . 5et increase in cash and cash e$uivalents Cash and cash e$uivalents, beginning of year Cash and cash e$uivalents, end of year ?;E,G<< );<,<<<* E,G<< );,<<<* );,<<<* ?::,<<< E,G<< 9,<<< :<,G<< ):;,<<<* ):;,<<<* H,G<< :,<<< ? :<,G<<

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%urpose of financial statements

The ob(ective of financial statements is to provide information about the financial position) performance and changes in financial position of an enterprise that is useful to a ide range of users in ma'ing economic decisions. !inancial statements should be understandable, relevant, reliable and comparable. 7eported assets, liabilities and e$uity are directly related to an organi#ation's financial position. 7eported income and e.penses are directly related to an organi#ation's financial performance. !inancial statements are intended to be understandable by readers ho have +a reasonable 'no ledge of business and economic activities and accounting and ho are illing to study the information diligently.

% ners and managers re$uire financial statements to ma'e important business decisions that affect its continued operations. !inancial analysis is then performed on these statements to provide management ith a more detailed understanding of the figures. These statements are also used as part of management's annual report to the stoc'holders. Employees also need these reports in ma'ing collective bargaining agreements )CB"* ith the management, in the case of labor unions or for individuals in discussing their compensation, promotion and ran'ings. ho are

;. External *sers+ are potential investors, ban's, government agencies and other parties

outside the business but need financial information about the business for a diverse number of reasons.

/rospective investors ma'e use of financial statements to assess the viability of investing in a business. !inancial analyses are often used by investors and is prepared by professionals )financial analysts*, thus providing them ith the basis in ma'ing investment decisions.

!inancial institutions )ban's and other lending companies* use them to decide company ith fresh debentures* to finance e.pansion and other significant e.penditures.

hether to grant a

or'ing capital or e.tend debt securities )such as a long3term ban' loan or

Covernment entities )ta. authorities* need financial statements to ascertain the propriety and accuracy of ta.es and other duties declared and paid by a company.
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4edia and the general public are also interested in financial statements for a variety of reasons.

,overnment financial statements

The rules for the recording, measurement and presentation of government financial statements may be different from those re$uired for business and even for non3profit organi#ations. They may use either of t o accounting methods& accrual accounting, or cash accounting, or a combination of the t o. " complete set of chart of accounts is also used that is substantially different from the chart of a profit3 oriented business

Audit and legal implications

"lthough the legal statutes may differ from country to country, an audit of financial statements are usually, but not e.clusively re$uired for investment, financing, and ta. purposes. These are usually performed by independent accountants or auditing firms. 7esults of the audit are summari#ed in an audit report that either provide an un$ualified opinion on the financial statements or $ualifications as to its fairness and accuracy. The audit opinion on the financial statements is usually included in the annual report. There has been much legal debate over ho an auditor is liable to. 0ince audit reports tend to be precedent. In Canada, auditors are liable

addressed to the current shareholders, it is commonly thought that they o e a legal duty of care to them. But this may not be the case as determined by common la only to investors using a prospectus to buy shares in the primary mar'et. In the United Kingdom, they have been held liable to potential investors hen the auditor as a are of the potential investor and ho they ould use the information in the financial statements. 5o adays auditors tend to include in their report liability restricting language, discouraging anyone other than the addressees of their report from relying on it. (iability is an important issue& in the UK, for e.ample, auditors have unlimited liability.

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Standards and regulations

8ifferent countries have developed their o n accounting principles over time, ma'ing international comparisons of companies difficult. To ensure uniformity and comparability bet een financial statements prepared by different companies, a set of guidelines and rules are used. Commonly referred to as Cenerally "ccepted "ccounting /rinciples )C""/*, these set of guidelines provide the basis in the preparation of financial statements. 7ecently there has been a push to ards standardi#ing accounting rules made by the International "ccounting 0tandards Board )+I"0B+*. I"0B develops International !inancial 7eporting 0tandards that have been adopted by "ustralia, Canada and the European Union )for publicly $uoted companies only*, are under consideration in 0outh "frica and other countries. The United 0tates !inancial "ccounting 0tandards Board has made a commitment to converge the U.0. C""/ and I!70 over time.

Inclusion in annual reports

To entice ne investors, most public companies assemble their financial statements on fine paper ith

pleasing graphics and photos in an annual report to shareholders, attempting to capture the e.citement and culture of the organi#ation in a +mar'eting brochure+ of sorts. Usually the company's chief e.ecutive ill rite a letter to shareholders, describing management's performance and the company's financial highlights. In the United 0tates, prior to the advent of the internet, the annual report effective ay for corporations to communicate as considered the most ent

ith individual shareholders. Blue chip companies

to great e.pense to produce and mail out attractive annual reports to every shareholder. The annual report as often prepared in the style of a coffee table boo'.

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