Preparing financial statements for your company is vital for its health, even though it may not be the most attractive aspect of managing a small business. Proper financial data helps you determine your company’s financial position at a specific point in time and over a designated period.
Income Statement
The income statement, also known as the profit and loss statement, is important because it shows your company’s overall profitability for the relevant time period. Information about sales revenue and expenses from accounting records and the general ledger is used to prepare the income statement. The income statement displays revenue from primary income sources, such as sales of the company’s products, and secondary sources, such as if the company rents out part of its commercial property.
The income statement also shows the business expenses for the time period, including operating expenses and expenses from secondary activities, and finally losses from any activity, including current depreciation. It should be noted that the depreciation outlined in the income statement is considered depreciation over the relevant time period only, not the total depreciation of the asset from the time the asset was acquired.
The bottom line of the income statement is net income or profit. Net income is either retained for growth in the company or paid out as dividends to the company’s owners and investors, depending on the company’s dividend policy.
Statement of Retained Earnings
The statement of retained earnings is the second financial statement you need to prepare in the accounting cycle. Net profit or loss must be calculated before preparing the statement of retained earnings.
After determining the profit or loss from the income statement, you can prepare this statement to find out what total retained earnings you have so far and how much you will pay to investors in your profits, if any. This statement shows the distribution of profits that are retained by the company and which are distributed as dividends.
As the name suggests, the amount of retained earnings is the profit that is retained by the company for growth, distinguishing it from the profits that are distributed to shareholders as dividends or to other investors as a share of distributed profits.
Balance Sheet
No financial statement can be prepared without the balance sheet. The balance sheet is the financial statement that tracks the company’s financial position at a specific point in time, typically at the end of the accounting cycle. It is a statement that shows what your company owns in assets and what it owes in liabilities. Your assets must equal your liabilities plus owner’s equity or investments. You have used your liabilities and equity to purchase your assets. The balance sheet displays your company’s financial position concerning assets and liabilities/equity at a specific point in time.
Note: The general ledger is the central element of your accounting system – every financial transaction your company makes is recorded chronologically in the debtor and creditor records.
The entries in the balance sheet come from the general ledger, and the format resembles the accounting equation. Assets, liabilities, and equity are determined for the end of another accounting cycle.
Note: Regarding depreciation: Unlike the depreciation outlined in the income statement, the depreciation shown in the balance sheet – a snapshot of the company at the end of the accounting cycle – is the total accumulated depreciation from the day the asset was acquired to the present.
Cash Flow Statement
Even if your company is making a profit, it may be suffering from cash flow shortages. The cash flow statement compares two time periods of financial statements and shows how cash in the accounts of revenue, expenses, assets, liabilities, and equity has changed during these periods.
The cash flow statement should be prepared last because it takes information from the three financial statements that have been previously prepared. The cash flow statement divides cash flows into operating cash flows, investing cash flows, and financing cash flows. The final result is the net change in cash flows for a certain period and gives the owner a very comprehensive picture of the cash position of the company.
It shows
The cash flow statement shows the company’s financial position on a cash basis rather than an accrual basis. The cash basis provides a record of revenues that have actually been received from the company’s customers in most cases. The accrual basis recognizes and records revenues when they are earned. If the company has extended billing terms, such as 30 days net, 60 days 1%, then these two methods can produce significantly different results.
Frequently Asked Questions (FAQ)
What are retained earnings?
Retained earnings refer to the company’s net profit after it has made payments to other shareholders’ equity – earnings that are “retained” by the company.
What is included in the financial statement?
Financial statements are summarized documents that provide details about a company’s financial position at a specific point in time. Typically, the balance sheet, cash flow statement, and income statement or profit and loss statement are included.
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Source: https://www.thebalancemoney.com/how-to-prepare-financial-statements-393008
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