Table of Contents

Defining Financial Statements 2

Balance Sheet 2
Types of Balance Sheet 3
Standard Format of a Balance Sheet 4
Sample Balance Sheet 5
Income Statement 6
Usefulness and limitations of Income Statement 6
Items on an Income Statement 7
Operating Section 7
Non-Operating Section 8
General format of an Income Statement 8
Statement of Retained Earnings 9
Cash flow Statement 10
Cash flow Activities 11
Sample cash flow statement 11
Purpose of financial statements 12
Government financial statements 13
Audit and legal implications 13
Standards and regulations 14
Inclusion in annual reports 15

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 Financial statements
These are the formal records of a business' financial activities.

In British English, including United Kingdom company law, financial statements are often referred to as
accounts, although the term financial statements are also used, particularly by accountants.

Financial statements give us a bird view of a business' financial condition in both short and long term.
All 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 organization's balances. Assets, liabilities and ownership equity are listed as of a specific date, such as
the end of its financial year. A balance sheet is often described as a snapshot of a company's financial
condition. Of the four basic financial statements, the balance sheet is the only statement which applies to
a single point in time.

A company balance sheet has three parts: assets, liabilities and ownership equity. The main categories of
assets are usually listed first and are followed by the liabilities. The difference between the assets and

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the liabilities is known as equity or the net assets or the net worth of the company and according to the
accounting equation, net worth must equal assets minus liabilities.

Another way to look at the same equation is that assets equals liabilities plus owner's equity. Looking at
the equation in this way shows how assets were financed: either by borrowing money (liability) or by
using the owner's money (owner's equity). Balance sheets are usually presented with assets in one
section and liabilities and net worth in the other section with the two sections "balancing."

A business operating entirely in cash can measure its profits by withdrawing the entire bank balance at
the end of the period, plus any cash in hand. However, many businesses are not paid immediately; they
build up inventories of goods and they acquire buildings and equipment. In other words: businesses have
assets and so they can not, even if they want to, immediately turn these into cash at the end of each
period. Often, these businesses owe money to suppliers and to tax authorities, and the proprietors do not
withdraw all their original capital and profits at the end of each period. In other words businesses also
have liabilities.

Types of Balance Sheet

Personal balance sheet
US small business balance sheet
Public Business Entities balance sheet structure

Format of a Standard Balance Sheet.

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ASSETS

• current assets + cash in the bank + petty cash = net cash (by totalling the previous three items);
• inventory + accounts receivable + net cash = total current assets
• fixed assets + land + buildings - depreciation = net land and buildings
• equipment - depreciation = net equipment
• total assets

LIABILITIES

• accounts payable + wages payable + taxes payable = total current liabilities

• long term loans + morgage = total long term liabilities
• total liabilities

EQUITY

• owners equity + owners draws + retained earnings + current earnings = total earnings
• total equity

COMPANY NAME IN BLOCK LETTERS

Balance Sheet

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 December 31, 20XX

Assets Liabilities and Owner’s Equity

Cash $ xx,xxx Liabilities $ xx,xxx

Accounts Receivable xx,xxx Notes Payable xx,xxx

Inventory xx,xxx Accounts Payables xx,xxx

Prepaid Insurance xx,xxx Total Liabilities xx,xxx

Land xx,xxx

Building xx,xxx Owner’s Equity

Equipments xx,xxx Person’s Capital xx,xxx

Total Assets $ xx,xxx Total Liabilities and Owner’s Equity $ xx,xxx

At the end of your balance sheet, if ASSETS = LIABILITIES + EQUITY, then you've done it properly.
Congratulations!

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Income statement
Income statement, also called profit and loss statement (P&L), is a company's financial statement that
indicates how the revenue (money received from the sale of products and services before expenses are
taken out, also known as the "top line") is transformed into the net income (the result after all revenues
and expenses have been accounted for, also known as the "bottom line"). The purpose of the income
statement is to show managers and investors whether 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 with the balance sheet, which represents a single moment in time.

Charitable organizations that are required to publish financial statements do not produce an income
statement. Instead, they produce a similar statement that reflects funding sources compared against
program expenses, 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 flows.

However, 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).
• Some numbers depend on accounting methods used (e.g. using FIFO or LIFO accounting to
measure inventory level).
• Some numbers depend on judgments and estimates (e.g. depreciation expense depends on
estimated useful life and salvage value)

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Items on income statement

Operating section

• Revenue - Cash inflows 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 major operations. Usually presented as sales minus sales discounts, returns, and
allowances.
• Expenses - Cash outflows or other using-up 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 major operations.
o General and administrative expenses (G & A) - represent expenses to manage the
business (officer salaries, legal and professional fees, utilities, insurance, depreciation of
office building and equipment, office rents, office supplies)
o Selling expenses - represent expenses needed to sell products (e.g., sales salaries,
commissions and travel expenses, advertising, freight, shipping, depreciation of sales
store buildings and equipment)
o Selling General and Administrative expenses (SG&A or SGA) - consist of the combined
payroll costs (salaries, commissions, and travel expenses of executives, sales people and
employees), and advertising expenses a company incurs. SGA is usually understood as a
major portion of non-production related costs, opposing production related costs such as
raw material and (direct) labour
o R & D expenses - represent expenses included in research and development
o Depreciation - is the charge for a specific period (i.e. year, accounting period) with
respect to fixed assets that have been capitalised on the balance sheet.

Non-operating section

• Other revenues or gains - 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 infrequent, but
not both (e.g. sale of securities or fixed assets)

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 • Other expenses or losses - expenses 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

$ $
Revenues
GROSS PROFIT (including rental income) 496,397
--------
Expenses:
ADVERTISING 6,300
BANK & CREDIT CARD FEES 144
BOOKKEEPING 3,350
EMPLOYEES 88,000
ENTERTAINMENT 5,550
INSURANCE 750
LEGAL & PROFESSIONAL SERVICES 1,575
LICENSES 632
PRINTING, POSTAGE & STATIONERY 320
RENT 13,000
RENTAL MORTGAGES AND FEES 74,400
UTILITIES 491
--------
TOTAL EXPENSES (194,512)
--------
NET INCOME 301,885
========

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Statement of retained earnings
The Statement of Retained Earnings (also known as Equity Statement, Statement of Owner's
Equity for a single proprietorship, Statement of Partner's Equity for partnership, and Statement of
Retained Earnings and Stockholders' Equity for corporation) is one of the basic financial statements
as per Generally Accepted Accounting Principles, and it explains the changes in a company's retained
earnings over the reporting period. It breaks down changes affecting the account, such as profits or
losses from operations, dividends paid, and any other items charged or credited to retained earnings. A
retained earnings statement is required by Generally Accepted Accounting Principles (GAAP) whenever
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. Retained earnings are part of the balance sheet (another basic financial
statement) under "stockholders equity," and is mostly affected by net income earned during a period of
time by the company less any dividends paid to the company's owners / stockholders. The retained
earnings account on the balance sheet is said to represent an "accumulation of earnings" since net profits
and losses are added/subtracted from the account from period to period.

The general equation can be expressed as following:

Ending Retained Earnings = Beginning Retained Earnings - Investments - Dividends Paid + Net Income

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Cash flow statement
In financial accounting, a cash flow statement or statement of cash flows is a financial statement that
shows a company's flow of cash. The money coming into the business is called cash inflow, and money
going out from the business is called cash outflow. The statement shows how changes in balance sheet
and income accounts affect cash and cash equivalents, and breaks the analysis down to operating,
investing, and financing activities. As an analytical tool, the statement of cash flows is useful in
determining the short-term viability of a company, particularly its ability to pay bills. International
Accounting Standard 7 (IAS 7) is the International Accounting Standard that deals with cash flow
statements. People and groups interested in cash flow statements include:

• Accounting personnel, who need to know whether the organization will be able to cover payroll
and other immediate expenses
• Potential lenders or creditors, who want a clear picture of a company's ability to repay
• Potential investors, who need to judge whether the company is financially sound
• Potential employees or contractors, who need to know whether the company will be able to
afford compensation

Purpose

The cash flow statement was previously known as the statement of changes in financial position or
flow of funds statement. The cash flow statement reflects a firm's liquidity 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 summarizes a firm's financial transactions over an interval of time. These two
financial statements reflect the accrual basis accounting used by firms to match revenues with the
expenses associated with generating those revenues. The cash flow statement includes only inflows and
outflows of cash and cash equivalents; it excludes transactions that do not directly affect cash receipts
and payments. These noncash transactions include depreciation or write-offs on bad debts to name a
few. The cash flow statement is a cash basis report on three types of financial activities: operating
activities, investing activities, and financing activities. Noncash activities are usually reported in
footnotes.

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The cash flow statement is intended to

1. provide information on a firm's liquidity and solvency and its ability to change cash flows in
future circumstances
2. provide additional information for evaluating changes in assets, liabilities and equity
3. improve the comparability of different firms' operating performance by eliminating the effects of
different accounting methods
4. indicate the amount, timing and probability of future cash flows

The cash flow statement has been adopted as a standard financial statement because it eliminates
allocations, which might be derived from different accounting methods, such as various timeframes for
depreciating fixed assets.

Cash flow activities

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

Sample cash flow statement using the direct method

Cash flows from operating activities
Cash receipts from customers $27,500
Cash paid to suppliers and employees (20,000)
Cash generated from operations (sum) 7,500
Interest paid (2,000)
Income taxes paid (2,000)
Net cash flows from operating activities $11,000
Cash flows from investing activities
Proceeds from the sale of equipment 7,500
Dividends received 3,000
Net cash flows from investing activities 10,500
Cash flows from financing activities
Dividends paid (12,000)
Net cash flows used in financing activities (12,000)
.
Net increase in cash and cash equivalents 9,500
Cash and cash equivalents, beginning of year 1,000
Cash and cash equivalents, end of year $ 10,500

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Purpose of financial statements
The objective 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 wide range of users in
making economic decisions. Financial statements should be understandable, relevant, reliable and
comparable. Reported assets, liabilities and equity are directly related to an organization's financial
position. Reported income and expenses are directly related to an organization's financial performance.

Financial statements are intended to be understandable by readers who have "a reasonable knowledge of
business and economic activities and accounting and who are willing to study the information diligently.

• Owners and managers require financial statements to make important business decisions that
affect its continued operations. Financial analysis is then performed on these statements to
provide management with a more detailed understanding of the figures. These statements are
also used as part of management's annual report to the stockholders.

• Employees also need these reports in making collective bargaining agreements (CBA) with the
management, in the case of labor unions or for individuals in discussing their compensation,
promotion and rankings.

2. External Users: are potential investors, banks, government agencies and other parties who are
outside the business but need financial information about the business for a diverse number of reasons.

• Prospective investors make use of financial statements to assess the viability of investing in a
business. Financial analyses are often used by investors and is prepared by professionals
(financial analysts), thus providing them with the basis in making investment decisions.

• Financial institutions (banks and other lending companies) use them to decide whether to grant a
company with fresh working capital or extend debt securities (such as a long-term bank loan or
debentures) to finance expansion and other significant expenditures.

• Government entities (tax authorities) need financial statements to ascertain the propriety and
accuracy of taxes and other duties declared and paid by a company.

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 • Media and the general public are also interested in financial statements for a variety of reasons.

Government financial statements

The rules for the recording, measurement and presentation of government financial statements may be
different from those required for business and even for non-profit organizations. They may use either of
two accounting methods: accrual accounting, or cash accounting, or a combination of the two. A
complete set of chart of accounts is also used that is substantially different from the chart of a profit-
oriented business

Audit and legal implications

Although the legal statutes may differ from country to country, an audit of financial statements are
usually, but not exclusively required for investment, financing, and tax purposes. These are usually
performed by independent accountants or auditing firms. Results of the audit are summarized in an audit
report that either provide an unqualified opinion on the financial statements or qualifications 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 who an auditor is liable to. Since audit reports tend to be
addressed to the current shareholders, it is commonly thought that they owe a legal duty of care to them.
But this may not be the case as determined by common law precedent. In Canada, auditors are liable
only to investors using a prospectus to buy shares in the primary market. In the United Kingdom, they
have been held liable to potential investors when the auditor was aware of the potential investor and how
they would use the information in the financial statements. Nowadays auditors tend to include in their
report liability restricting language, discouraging anyone other than the addressees of their report from
relying on it. Liability is an important issue: in the UK, for example, auditors have unlimited liability.

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Standards and regulations

Different countries have developed their own accounting principles over time, making international
comparisons of companies difficult. To ensure uniformity and comparability between financial
statements prepared by different companies, a set of guidelines and rules are used. Commonly referred
to as Generally Accepted Accounting Principles (GAAP), these set of guidelines provide the basis in the
preparation of financial statements.

Recently there has been a push towards standardizing accounting rules made by the International
Accounting Standards Board ("IASB"). IASB develops International Financial Reporting Standards that
have been adopted by Australia, Canada and the European Union (for publicly quoted companies only),
are under consideration in South Africa and other countries. The United States Financial Accounting
Standards Board has made a commitment to converge the U.S. GAAP and IFRS over time.

Inclusion in annual reports

To entice new investors, most public companies assemble their financial statements on fine paper with
pleasing graphics and photos in an annual report to shareholders, attempting to capture the excitement
and culture of the organization in a "marketing brochure" of sorts. Usually the company's chief
executive will write a letter to shareholders, describing management's performance and the company's
financial highlights.

In the United States, prior to the advent of the internet, the annual report was considered the most
effective way for corporations to communicate with individual shareholders. Blue chip companies went
to great expense to produce and mail out attractive annual reports to every shareholder. The annual
report was often prepared in the style of a coffee table book.

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