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The income statement is a historical record of the trading of a business over a

specific period (normally one year). It shows theprofit or loss made by the
business which is the difference between the firm's total income and its total
costs.
The income statement serves several important purposes:

Allows shareholders/owners to see how the business has performed and whether it has
made an acceptable profit (return)

Helps identify whether the profit earned by the business is sustainable ("profit quality")

Enables comparison with other similar businesses (e.g. competitors) and the industry as
a whole

Allows providers of finance to see whether the business is able to generate sufficient
profits to remain viable (in conjunction with the cash flow statement)

Allows the directors of a company to satisfy their legal requirements to report on the
financial record of the business

The structure and format of a typical income


statement is illustrated below:

The lines in the income statement can be briefly described as follows:


Category

Explanation

Revenue

The revenues (sales) during the period are recorded here. Sometimes
referred to as the "top line" revenue shows the total value of sales made
to customers

Cost of sales

The direct costs of generating the recorded revenues go into "cost of


sales". This would include the cost of raw materials, components, goods
bought for resale and the direct labour costs of production.

Gross profit

The difference between revenue and cost of sales. A simple but very useful
measure of how much profit is generated from every 1 of revenue before
overheads and other expenses are taken into account. Is used to calculate
the gross profit margin (%)

Distribution &
administration
expenses

Operating costs and expenses that are not directly related to producing the
goods or services are recorded here. These would include distribution costs
(e.g. marketing, transport) and the wide range of administrative expenses
or overheads that a business incurs.

Operating profit

A key measure of profit. Operating profit records how much profit has
been made in total from the trading activities of the businessbefore any
account is taken of how the business is financed.

Finance expenses

Interest paid on bank and other borrowings, less interest income received
on cash balances, is shown here. A useful figure for shareholders to assess
how much profit is being used up by the funding structure of the business.

Profit before tax

Calculated as operating profit less finance expenses

Tax

An estimate of the amount ofcorporation tax that is likely to be payable


on the recorded profit before tax

Profit attributable
to shareholders

The amount of profit that is left after the tax has been accounted for. The
shareholders then decide how much of this is paid out to them in dividends
and how much is left in the business ("retained earnings" in the equity

section of the balance sheet

Overview of Financial Statements


Financial statements are used by managers, shareholders, investors, lenders, and the government for different
reasons and purposes. Essentially, financial statements show the financial status of an entity and are comprised
of income statement, balance sheet, and cash flow statement.

The Income Statement


Also referred as an earnings statement or a profit and loss (P&L) statement, the income statement details the
business financial performance for a certain month, quarter, and year. Unlike the balance sheet, the income
statement evinces an entitys business activity over time. In addition, it rehashes the generated income and
deducts the incurred expenditures in the derivation of that income in order to compute the net profit or loss for
a given accounting period.
The income statement, together with the balance sheet, is an essential financial report which illustrates the
revenue-generating capacity and financial status of an entity.

Importance of an Income Statement


An income statement fundamentally addresses queries related to the financial performance of a business (e.g.
does it generate profit or not?). Moreover, it describes the results of business transactions that generate income
in exchange for goods or rendered services. In addition, it reflects the incurred expenditures in relation to
activities involved in generating income. The income statement indicates the net profit gained by a business
irrespective of whether the entity generated profit or incurred losses.
The Internal Revenue Service (IRS) compels businesses to prepare an income statement. It is solely the
financial statement necessitated by IRS as it is utilized in estimating taxes on the earned profits. Also, a
frequently prepared income statement will provide owners up-to-date and essential information with regards to
the income and expenditures and inform them whether adjustments should be made in order to make up for
losses or curtail expenses.

Preparing an Income Statement


According to a guide from Baruch College The City University of New York, the income statement follows
the accrual accounting system wherein earned income and incurred expenses are both recorded. Thus, earned
income may consist of sales on credit that the entity has yet to receive cash while expenses may include bills
the entity has not yet settled.
In constructing an income statement, the following four profit measures should be indicated: gross profit,
operating profit, profit before taxes, and net profit. Gross profit is determined by deducting net sales from the
cost of goods sold, or to simply put,

Gross Profit = Net Sales Cost of Goods Sold


Also,
Net Operating Profit = Gross Profit Selling and Administrative Expenses
Profit Before Taxes = Net Operating Profit + (Other Income Other Expenses)
Net Profit (or Net Loss) = Profit Before Taxes Income Taxes
The first step in preparing an income statement is to fill in the heading of the worksheet with the companys
name and the accounting period that is being examined. Next, specify the total sales or any allowances and
compute for the net sales. The cost of sales will also be determined in order to calculate the gross profit. Then,
compute for the net operating profit through the selling, general, and administrative expenses disclosed in the
worksheet. Lastly, calculate for the net profit from the stated other incomes or expenses and for the net profit
before income taxes in the worksheet.

Net Sales
Net sales are the overall sales for the accounting period minus the allowances for the trade discounts and
returns. The permitted amount for returns differs depending on the type of business. Net sales can also be
described as the amount of money derived from sold goods or rendered services. The equation for the net sales
is,
Net Sales = Gross Sales (Return and Allowances)

Cost of Goods Sold


Also referred as cost of sales, the cost of goods sold is the total amount paid for the sold products throughout
the accounting period. It should be noted that the cost of goods sold does not cover the selling or
administrative expenses. The cost of goods sold is merely the price of goods or the cost incurred by the
business in order to manufacture its products or prepare its services.
In mathematical terms,
Cost of Goods Sold = Inventory at the start + Purchased materials Ending inventory
There are instances wherein there will be no cost of goods sold. This applies to service and professional
companies since they have no inventory of their goods but earn income from fees, royalties, and commissions.
However, the expenses in providing their services will be reflected on their selling and administrative
expenses.
In the case of wholesalers and retailers, there are various ways on how to compute the cost of goods sold. They
can either use a direct or indirect method.
The cost of goods sold can also be indirectly determined via the deflating sales figure. The equations are

Cost of Goods Sold ($) = Total Sales ($) Gross Profit ($), where
Gross Profit ($) = Total Sales x Gross Margin (%)
The technique in accumulating the cost of goods sold for manufacturers is different compared to the method
used by retailers and wholesalers. Manufacturers include the direct labor, indirect labor, factory overhead, and
materials and supply.

Selling and Administrative Expenses


Selling expenses and administrative expenses are the two kinds of expenses reported by all types of companies
on their income statement. Selling expenses are incurred expenditures, either directly or indirectly, throughout
the marketing process. They can be the payroll of salespeople, sales office costs, advertising, and shipping
among others. Basically, these are expenses when taking and fulfilling orders.
On the other hand, administrative expenses are expenditures during the business operation excluding the sales
of goods. These expenses can be in the form of payroll for non-sales personnel, overhead expenses, and
utilities among other things.

Other Income and Expenses


These are income or expense items that are not directly associated with the business proceedings. Other
incomes include earnings from interests, dividends, and royalties. On the contrary, other expenses are
unforeseen losses such as loss from the disposition of equipment or machineries.

Income Taxes
Income taxes are an inevitable part of any business transaction and can be taxed by the local, state, and/or
federal government. Income taxes can be calculated by using published tax tables.

Net Income
Also termed as net profit or earnings, net income is the last item on the financial statement. It shows the gained
base profit by an entity during the specified accounting period.

Issues on Financial Statements


Through an entitys income statement, their financial position can be accurately established. However, there
are some concerns that may affect this desired outcome.
Items such as brand recognition, organizational reputation, and customer loyalty are important and relevant
business items but are not evaluated and reported on the income statement.

By using different valuation methods permitted in accounting, various profit results will be obtained. For
instance, FIFO and LIFO will each yield disparate profit outcomes.
Some values recorded on the income statement are based on judgments and appraisals. An example is the
depreciation expenses which is established on approximation of its useful life and salvage value.
The income statement cannot specify the owners assets and liabilities, and the Accounts Receivable and
Payable.

A balance sheet is a snapshot of a business's financial condition at a specific


moment in time, usually at the close of an accounting period. A balance sheet
comprises assets, liabilities, and owners' or stockholders' equity. Assets and
liabilities are divided into short- and long-term obligations including cash
accounts such as checking, money market, or government securities. At any
given time, assets must equal liabilities plus owners' equity. An asset is
anything the business owns that has monetary value. Liabilities are the claims
of creditors against the assets of the business.
What is a balance sheet used for?
A balance sheet helps a small-business owner quickly get a handle on the
financial strength and capabilities of the business. Is the business in a position
to expand? Can the business easily handle the normal financial ebbs and
flows of revenues and expenses? Or should the business take immediate
steps to bolster cash reserves?
Balance sheets can identify and analyze trends, particularly in the area of
receivables and payables. Is the receivables cycle lengthening? Can
receivables be collected more aggressively? Is some debt uncollectable? Has
the business been slowing down payables to forestall an inevitable cash
shortage?
Balance sheets, along with income statements, are the most basic elements in
providing financial reporting to potential lenders such as banks, investors, and
vendors who are considering how much credit to grant the firm.

1. Assets: Assets are subdivided into current and long-term


assets to reflect the ease of liquidating each asset. Cash, for
obvious reasons, is considered the most liquid of all assets.
Long-term assets, such as real estate or machinery, are less
likely to sell overnight or have the capability of being quickly
converted into a current asset such as cash.

2. Current assets: Current assets are any assets that can be easily
converted into cash within one calendar year. Examples of
current assets would be checking or money market accounts,
accounts receivable, and notes receivable that are due within
one year's time.
Cash
Money available immediately, such as in checking accounts,
is the most liquid of all short-term assets.
Accounts receivables
This is money owed to the business for purchases made by
customers, suppliers, and other vendors.
Notes receivables
Notes receivables that are due within one year are current
assets. Notes that cannot be collected on within one year
should be considered long-term assets.

3. Fixed assets: Fixed assets include land, buildings, machinery,


and vehicles that are used in connection with the business.
Land
Land is considered a fixed asset but, unlike other fixed
assets, is not depreciated, because land is considered an

asset that never wears out.


Buildings
Buildings are categorized as fixed assets and are depreciated
over time.
Office equipment
This includes office equipment such as copiers, fax machines,
printers, and computers used in your business.
Machinery
This figure represents machines and equipment used in your
plant to produce your product. Examples of machinery might
include lathes, conveyor belts, or a printing press.
Vehicles
This would include any vehicles used in your business
Total fixed assets
This is the total dollar value of all fixed assets in your
business, less any accumulated depreciation.
4. Total assets: This figure represents the total dollar value of both
the short-term and long-term assets of your business.

5. Liabilities and owners' equity: This includes all debts and


obligations owed by the business to outside creditors,
vendors, or banks that are payable within one year, plus the
owners' equity. Often this side of the balance sheet is simply
referred to as "liabilities."
Accounts payable
This includes all short-term obligations owed by your
business to creditors, suppliers, and other vendors. Accounts

payable can include supplies and materials acquired on


credit.
Notes payable
This represents money owed on a short-term collection cycle
of one year or less. It may include bank notes, mortgage
obligations, or vehicle payments.
Accrued payroll and withholding
This includes any earned wages or withholdings that are
owed to or for employees but have not yet been paid.
Total current liabilities
This is the sum total of all current liabilities owed to creditors
that must be paid within a one-year time frame.
Long-term liabilities
These are any debts or obligations owed by the business that
are due more than one year out from the current date.
Mortgage note payable
This is the balance of a mortgage that extends out beyond
the current year. For example, you may have paid off three
years of a 15-year mortgage note, of which the remaining 11
years, not counting the current year, are considered longterm.
Owners' equity
Sometimes this is referred to as stockholders' equity. Owners'
equity is made up of the initial investment in the business as
well as any retained earnings that are reinvested in the
business.
Common stock

This is stock issued as part of the initial or later-stage


investment in the business.
Retained earnings
These are earnings reinvested in the business after the
deduction of any distributions to shareholders, such as
dividend payments.

6. Total liabilities and owners' equity:This comprises all debts and


monies that are owed to outside creditors, vendors, or banks
and the remaining monies that are owed to shareholders,
including retained earnings reinvested in the business.

GUIDE THROUGH THE


BALANCE SHEET & ITS KEY
TERMS
DEIMAR GUTIERREZ

The Balance Sheet (BS) is a financial statement which gives a


snapshot of the companies assets and the funds that are
related

to

those

assets

at

an

instant

in

time.

*Note: I will use a two column layout as it is easier to


understand.
We

can

split

the

BS

in

two

mayor

blocks:

Assets

and

Liabilities/Funds:
Assets

Liabilities/Funds
Things owned
by
the business
$1000
Amounts owed
by
the business
$1000

The blue block, assets, representing the company uses has


given its resources. In other how the company spent the
money. The green block, Liabilities, represents the sources of

that money. Whether through the contribution of partners or


debt, the whole block can be considered as liabilities, because
the company is a legal entity independent of its owners.
As you may have noticed there is a balance between the two
blocks. this occurs given that all the resources that a company
obtains, either through loans or contributions of partners are
used in assets.
Total

Assets ($1000)

The

Total

Balance

Liabilities/Funds

Sheet

($1000)

Structure:

We can divide our balance in 5 mayor blocks. Lets start by the


Assets:
Total Assets = Current Assets (CA) + Fixed Assets (FA)
1.Current Assets (CA)
Assets

Liabilities/Funds
CA

This

block

includes

all short-term assets. Short-

termmeans they can beconverted quickly and easilyinto cash.


Inventories: Rawmaterials, work inprogress, finishedgoods.
..

Accounts receivables:generally, they represent amounts d


ue fromcustomers.
Cash and cashequivalents: bankaccounts, cash
Miscellaneous: othershort-term assets, likepre-payments
2.Fixed Assets (FA)
Assets

Liabilities/Funds
FA
CA

The second mayor blockrepresents the longinvestments of thec


ompany.
Intangibles: They donot have a physicalpresence, like th
eGoodwill, patents andlicenses. Nevertheless,they have a
greatimpact in the balancesheet and the value ofa compa
ny. Forexample, check theimage below, whichrepresents t
he marketvalue of a coca-cola'soutstanding shares(the
market cap) in2007, with and withoutincluding the brandv
alue.
Net fixed assets:these are thosephysical itemsrequired f
oroperations.(Lands andBuildings,
offi ceequipment,machinery...)
Longterminvestments / otherassets: generally,it refers to s
hares inother companies. It isthe market value of acompa
ny'soutstanding shares.

*Note: the BS does not pretend to reflect the market value of


the

company

or

its

assets.

Total Liabilities = Current Liabilities (CL) + Long-term loans


(LTL)

Total

Owner

Assets = Total

Funds

(OF)

Liabilities therefore

Total Assets = Current Liabilities (CL) + Long-term loans (LTL)


+

Owner

Funds

3.Current Liabilities (CL)


Assets

Liabilities/Funds
FA
CA
CL

(OF)

All short-term assets (To bepaid within one year). Theaccounts


we can find in thisblock counterbalance thecurrent assets, and
theirrelation is reflected in thecash position of thecompany.

Accounts payable:Amounts due tosuppliers,

Short-term loans:Bank overdraft,interest on shorttermdebt.


Miscellaneous: bankaccounts

4. Long-term Liabilities (CL)


Assets

Liabilities/Funds
FA
CA
LTL
CL

All mortgages, term loans, bonds, etc., to be paid in a period


longer than a year. You can also classify them in medium (3-5
years)

and

5.
All

long

debt

Owner
claims
Assets

by

(from

to

Funds
the

owners

of

Liabilities/Funds

20

years).

(OF)
the

business:

FA
CA
OF
LTL
CL
Issued common stock:nominal value or book value is
the price used to bring owners of capital into the business.
It differs from the market valuewhich fluctuates.
Capital reserves: By the law in some countries is a
statutory

reserve.

This

account

covers

all

surpluses

accruing to the common stockholders that did not arise


from trading. Example: the revaluation of fixed assets, the
premiums on shares, currency gains, etc.
Revenue reserves: are amounts retained in the company
from normal trade. Example: revenue reserves, general
reserve, retained earnings.
Finally, let's give some numbers to our balance sheet, and
learn 4 key terms you will need to master, in order to analyse
the

performance

of

Assets

a
Liabilities/Funds

1.Fixed Assets
$700
2.Current Assets
$300

company.

5.Owners Funds
$450
4.Long Term L
$350
3.Current Liabilities
$200

1.

Total

Assets =

$700

FA)+

300

(CA)

$200

(CL)

or
Total

Assets =

$450(

FA)+

$350(CA)

2. Capital employed (CE) =fixed assets + investments +


inventory + accounts receivable + cash accounts payable and
short

terms

loans.

In other words CE = Total assets - Current liabilities. or CE =


Owners

Funds

Long

Term

liabilities

Capital Employed = ($700 + $300) - $200 or CE = $450 +


$350
Why is it important?Because it represents the
foundation

funds

3.

of

long

the

term

company.

Net

worth:

Net worth = $700 (FA) + $300 (CA) $200 (CL) $350 (LTL)
The value of the company isdeterminate by the value ofthe tota
l assets lessexternal liabilities. In otherwords, once acompany
pays all debts theremaining belongs to theowners of the compa
ny.
4. Working

capital

(WC)

It is a measure of liquidity (cash availability). It is the ability of


the company to meet the day a day cash demand. There are
companies

rich

in

assets,

Known as WC = Current Assets


$300

but

short

in

liquidity.

Current Liabilities ,

WC =
$200

It can also be defined as the difference between the long term


funds

and

the

fixed

assets.

WC = OF + LTL FA,
$350

WC = $450 +
-

WC = Capital employed (CE) FA

$700
WC = $750 -

$700
Which means that those long terms funds that are not linked to
fixed assets determine the working capital.