Basic Financial Statements
Saturday, October 3rd, 2009The 3 basic financial statements are:
- Income Statement (or Profit and Loss Account)
- Balance Sheet
- Cash-flow Statement
The Income Statement shows the revenues, expenses and profits during a determined period of time. The expenses shown in the Income Statements are those used up in generating the revenue. The revenue, is the revenue earned during that period, independent of whether the money from this revenue was received or not. Transactions in the Income Statement are recognized when they occur, not when money is received or paid (accural system). The objective of the Income Statement is to MATCH the revenue with the expenses required to generate it; but it does not deal with whether the money has been paid/received or not.
The Balance Sheet is a snapshot of the financial position of a company at a certain date. The assets are tangible, intangible or financial items owned by the company and that will provide it with future benefits. A fixed assets are th0se which have a useful life of more than one year. Depreciation is a measure (allocation) of the cost of a fix asset used to generate revenue during an accounting period (it has nothing to do with the value of the asset). Liabilities are obligations that the company has with outsiders. Equity is an obligation that the company has with its owners.
The Income Statement and the Balance Sheet are based on the accural system, thus, they do not explain what is happening with the cash. Therefore, it is very important to have an understanding of the Cash Flow Statement, which is mainly a rearrangement of the numbers in the BS and P&L in order to explain what is happening with the cash. And the CASH IS KING, because a company which might be showing profit in the Income Statement may actually be loosing money or going bankrupt (e.g. it has paid to all its providers but the customers have not yet paid to the company and therefore, the company has no money in the bank to pay its employees, etc).
The Manufacturing Account is produced only for internal purposes (its mainly a Management Accounting tool, not a Financial Accounting tool as these 3 which are also for external stakeholders); and it is done mainly because for a manufacturer it is in general quite difficult to calculate exactly how much is the cost of a finished good. Trading companies, which just buy cheap and sell more expensive, do not need to use a manufacturing account.
In the following spreadsheet you can see a summary of the main items included in these statements:
