BALANCE SHEET

A solid balance sheet is an essential financial statement and part of a complete Financial report. It can
be used to secure financing or take a snapshot of a company’s current financial state, but it can also be
used to evaluate the worth of your company over time.

1. UNDERSTAND THE BASIC EQUATION

The following equation is a simplified representation of what a balance sheet Calculates: The total sum
of your company’s assets equals the value of the company’s Liabilities and owner’s equity.
Assets = Liabilities + Owner’s Equity
As with any math equation, you can play around with the equation to isolate one Category. Most
business owners and investors use the following equation to Calculate the value of the company’s
equity.
Owner’s Equity = Assets – Liabilities
2. CALCULATE ASSETS
Assets, money, investments and products the business owns that can be converted Into cash: These
are what put companies in the financial positive. A thriving Company should have assets that are greater
than the sum of its liabilities; this Creates value in the company’s equity or stock, and opens up
opportunities for Financing.
It’s important to list your assets by their liquidity—the facility by which they can be Turned into cash—
starting with cash itself and moving into long-term investments At the end of the list. For the purpose of
an annual balance sheet, you can separate Your list between “current assets,” Anything that can be
converted into cash within A year or less, and “fixed assets,” Long-term possessions that can be sold or
that Retain value down the line, minus depreciation.
“Current Assets” May Include:
 Cash: All money in checking or savings accounts
 Accounts receivable: Money owed to the business by a client or customer
 Inventory: Any products or materials that have already been created or Acquired for the purpose of
sale
 Prepaid insurance: Any payments made in advance for business insurance Coverage or services
(this tends to be paid in advance for the year).
“Fixed Assets” May Include:
 Supplies: Important objects used for business operations (manufacturing Equipment, computers,
office furniture, company cars, etc.)
 Property: Any office building or land owned by the business
 Intangible assets: Intellectual property such as patents, copyrights, Trademarks and other
company rights that retain intrinsic value
3. DETERMINE LIABILITIES
Liabilities are the negative part of the equation; these include operational costs, debt And material
expenses. Generally speaking, the lower your liabilities, the greater the Value of your company (and
equity) can be. “current liabilities” Include cash spent, As well as any debts that must be paid out within
one year, while “fixed liabilities” Refer to bills due anytime after one year.
“Current Liabilities” May Include:
 Accounts Payable: Money owed by a business to its suppliers or partners
 Business Credit Cards: Company credit card bills due
 Operating Line Of Credit: Any money owed to a bank that has extended the Business an operating
line of credit
 Taxes Owed: Any federal and state taxes owed for one year
 Wages And Payroll: Employee compensation, including wages, medical Insurance, etc.
 Unearned Revenue: Any revenue garnered from a service or product that Has yet to be delivered to
the customer or client
“Fixed Liabilities” May Include:
 Long-Term Mortgages: Property or building mortgage expenses
 Bonds Payable: Long-term bonds owed to the government, as well as any Interest paid on the bond
(this interest is often semi-annual and can be Added to “current liabilities”)
 Pension Benefit Obligations: The total amount of money the company owes To employee pension
plans up to the current date
 Car Loan: Any long-term car loans on company vehicles (plus insurances Costs)
4. EQUITY VALUATION
Owner’s Equity = Assets – Liabilities
The value of your assets minus your liabilities will result in an estimation of the Value of your company’s
capital. If this equation results in a negative net worth, this Can be dangerous for a small business; it will
make it difficult for to secure financing, Which can be troubling for a company whose expenses are
already eclipsing its Profits.
If, however, a company has positive equity, this means that business owners have The option of
acquiring capital by selling part of their business through equity, Stocks and/or dividends.
In a sole proprietorship, this is called the “owner’s equity”; in a corporation, this is Called “stockholder’s
equity,” And it can include common stock, preferred stock, Paid-in capital, retained earnings, etc.
“Equity” May Include:
 Opening Balance Equity: The initial investment into the company
 Owner’s Draw: Portion of the revenue used by company’s owner
 Retained Earnings: The sum of a company’s consecutive earnings since it Began.
Note: Having an income statement will assist you in filling out this section, Since it helps you determine
the opening balance equity and the retained Earnings.
5. CONSIDER ALL APPLICATIONS

Example of a balance sheet:

THE STATEMENT OF INCOME
The statement of income describes the revenues and gains, expenses and losses along with the
resulting net income or net loss of the business due to its operating activities for a given period of time.

○ Revenues- are inflows of resources (usually cash or receivables) during the course of ordinary
operating activities. Revenue usually arises from the sale of services or goods. Revenue is
synonymous to the word income. The account titles used for revenues are modified depending on
the type of business operations. For service businesses, service income, professional fees, ticket
sales, etc. may be used. For merchandisers and manufacturers, sales or sales revenue are account
titles frequently used.
○ Gains- will also result to an inflow of resources but these do not arise from the main activity of the
enterprise but from those considered incidental activities like selling old equipment at a price above
its book value. Account title used for this transaction can be gain from sale of equipment.
○ Expenses are outflows of resources (usually paid in cash or incurred on credit) during the course of
ordinary operating activities. Expenses happen when assets are used in the normal course of doing
business. Examples of expenses are:salaries and wages expense, rent expense, utilities expense,
etc. Some expense account titles may reveal the nature of operations like cost of services used by
service businesses, cost of goods sold used by merchandising businesses, and cost of goods
manufactured and sold which is used by manufacturing businesses.
○ Losses will also result to an outflow of resources but these do not arise from the main activity of the
enterprise but from those that are considered incidental activities like selling an investment that the
company previously acquired at a price lower than its book value. The account title that can be used
for this transaction is loss from the sale of investment. The basic relationship of the elements shown
in the income statement is: Revenues (Gains) – Expenses (Losses) = Net profit or net loss

Net profit or net income is arrived at when the revenues and gains are greater than the expenses and
losses, indicating successful business operations during the period. If the reverse is true, i.e., expenses
and losses are greater than revenues and gains; the difference is called net loss.
Income Statement, or Profit and Loss Statement, is directly linked to balance sheet, cash flow statement
and statement of changes in equity.
The increase or decrease in net assets of an entity arising from the profit or loss reported in the income
statement is incorporated in the balances reported in the balance sheet at the period end.
The profit and loss recognized in income statement is included in the cash flow statement under the
segment of cash flows from operation after adjustment of noncash transactions. Net profit or loss during
the year is also presented in the statement of changes in equity.

Types of Business Operations

Businesses usually undertake three activities: investing, financing and operating. Operating activities
refer to the undertakings of the business that generate additional resources for the firm. Operating
activities involve using the firm’s resources to generate goods and services for sale at a profit. There are
three types of business operations: service, merchandising, and manufacturing. As a refresher from the
first module, let us expound further on these.
Service- A service business is involved in selling services. A doctor or a teacher practicing their
professions, a day-care center, or a big accounting firms like SGV & Co and Ernst & Young are all
engaged in service businesses.
Merchandising- A business that buys inventory that it will resell in retail or wholesale is a
merchandising business.A merchandising business ranges from a fruit-stand store to an on-line retailer
like Lazada or OLX, or a bookstore like National Bookstore or Fully-Booked.
Manufacturing- A manufacturing business usually does activities that converts raw materials into
finished products, and sells this to other firms or to individuals. Examples include: San Miguel
Corporation, Ayala Land, and Samsung.

The following is an example of an Income Statement for service business:

The above income statement is prepared using a single-step approach because after getting the totals
of revenue and expense items, the difference was arrived at by simply subtracting the two.
A single-step income statement is one of two commonly used formats for the income statement or
profit and loss statement. The single-step format uses only one subtraction to arrive at net income.
It is also to be noted from the above report that the heading of a statement of income usually consists of
the following:
 Business name
 Statement of income
 Period covered by the statement
On the other hand, here is an example of an Income Statement for merchandising business:
The multiple-step profit and loss statement segregates the operating revenues and operating
expenses from the no operating revenues, no operating expenses, gains, and losses. The multiple-step
income statement also shows the gross profit (net sales minus the cost of goods sold). The income
statement for merchandising businesses usually has seven sections:
 Net sales 
 Cost of goods sold
 Gross profit
 Operating expenses
 Operating income or operating loss
 Other revenues and gains (expenses and losses)

Net profit or net loss
There are three benefits to using a multiple-step income statement:
1. Multiple-step income statement clearly states the gross profit amount. Many readers of financial
statements monitor a company's gross margin (gross profit as a percentage of net sales). Readers may
compare a company's gross margin to its past gross margins and to the gross margins of the industry.
2. The multiple-step income statement presents the subtotal operating income, which indicates the profit
earned from the company's primary activities of buying and selling merchandise.
3. The bottom line of a multiple-step income statement reports the net amount for all the items on the
income statement. If the net amount is positive, it is labeled as net income. If the net amount is negative,
it is labeled as net loss

Important Terms
Some important definitions in relation to understanding the merchandising business of an income
statement are the following:
Net sales refer to total or gross sales less any sales discounts, and sales returns and allowances.
Sales discounts are reductions in the total sales price given to the customer if the account will be paid
within a short period of time. Assuming the credit term is 1/10, n/30, the customer will be given a 1%
discount if payment is received within 10 days from the invoice date. Assuming total credit sales of
₱50,000 was made on September 1 and the customer paid on or before September 11, an amount of
₱5,000, representing 1% of ₱50,000, will be deducted from the total amount due.
Sales returns and allowances are also reductions in the total selling price. Sales returns represent the
actual price of returned merchandise by the customer; sales allowances are reductions in the price
because of possible defects or damages in the products sold.
Cost of goods sold is the actual cost of the merchandise sold. It is the sum of the cost of merchandise
in the beginning inventory plus the net cost of goods purchased this period less the merchandise in the
ending inventory.

Merchandise inventory represents the total amount of inventory on hand.

Beginning inventory is the amount of inventory at the beginning of the period and ending inventory is
the amount remaining at the end of the period.
Net cost of goods purchased is the total or gross purchases less any purchase discounts and
purchase returns and allowances.
Purchase discounts are cash discounts representing reductions in the purchase price because the
buyer settled the account within the credit term.
Purchase returns and allowances are deducted in the purchase price either because of returns or
reductions due to defects or damages of goods purchased.
STATEMENT OF CHANGES IN EQUITY
Owner’s Equity
Capital is also known as Owner’s equity. It represents the right of the owner over the resources of the
firm. It is also called net assets, or residual assets. From the accounting equation, we can derive
owner’s equity

Usually it consists of the owner’s investment and the earned profit less any withdrawals made during a
given period

Forms of Business Organizations and the Equity Accounts

 Sole or single proprietorship This is a type of business which is owned by only one person.
Usually a sole proprietor (owner of the business), is also the manager or boss of his own business.
 Partnership By the contract of partnership, two or more people join together to contribute money,
property or industry for purposes of dividing the profits (or loss) among themselves.
 Corporation It is composed of five to fifteen people. It is organized by operation of the law and
considered the most complex form of a business organization. The following are the usual account
titles used for the equity of the owner or owners considering the forms of business organizations.

Parts of the Statement of Changes in Equity

Like the Statement of Financial Position and Statement of Income, which have different elements, the
Statement of Changes in Equity also has its own.
These are as follows:
Beginning capital represents the total capital at the start of the business. If the firm has been operating
in the past year, the beginning capital of the current year is the same the ending capital of the previous
year.
Investments made by the owner may represent the original investment made at the start of business,
and any additional investments thereafter. Investments are added to the capital beginning to arrive at the
total investments used during the year.
Net profit is also derived from the income statement and is also added to the beginning capital and
additional investments done during the year. If the business incurred a net loss, the same is deducted.
Withdrawals or drawings are resources of the firm which were taken by the owner for personal use.
Ending capital is the difference arrived at after deducting withdrawals from the sum of the beginning
capital, additional investments, and profit. Ending capital also represents the residual claim of the owner
on the total resources or assets of the firm after deducting the claims of creditors.

The following is an example of a Statement of Changes in Equity for a sole

proprietorship.

Similar to the heading of a statement of income, the statement of changes in equity will have to show:
 Name of business
 Statement of changes in equity
 Period covered by the statement

Steps in Preparing the Statement of Owner’s Equity

Step 1. Gather the needed information
The Statement of Changes in Owner's Equity is prepared second to the Income Statement. We will still
be using the same source of information. Again, the most appropriate source of information in preparing
financial statements would be the adjusted trial balance. Nonetheless, any report with a complete list of
updated accounts may be used. We will also be using the Income Statement later in the process.
Step 2. Prepare the Heading
The heading is made up of three lines. The first line contains the name of the company. The second line
shows the title of the report: it would be Statement of Changes in Owner's Equity, Statement of Owner's
Equity, or simply Statement of Changes in Equity. The third line shows the period covered. The report
covers a span of time; hence we use For the Year Ended, For the Quarter Ended, For the Month Ended,
etc.
Step 3. Capital at the beginning of the period
Report the capital balance at the beginning of the period reported – or the amount at the end of the
previous period. Remember that the ending balance of the last period is the beginning balance of the
current period.
Step 4. Add Additional Contribution
Contributions from the owner capital, hence added to the capital balance.
Step 5. Add Additional Contribution
Net income increases capital hence it is added to the beginning capital balance. Net income is equal to
all revenues minus all expenses.
Step 6. Deduct Owner’s withdrawals
Withdrawals made by the owner are recorded separately from contributions. You can easily find it in the
adjusted trial balance as "Owner, Drawings", "Owner, Withdrawals", or any other appropriate account.
Withdrawals decrease capital, hence are deducted.
Step 7. Compute for the ending balance
Compute for the balance of the capital account at the end of the period and draw the lines. One
horizontal line means that a mathematical operation has been performed. Two horizontal lines (double-
rule) are drawn below the final amount

STATEMENT OF CHANGES IN EQUITY is a report that shows the items that affect the capital or equity
account. Simply, we are just presenting this formula in a formal report:
Capital, ending = Capital, beg. + Additional Contributions + Net Income - Withdrawals
where: Net Income = Income - Expenses

IMPORTANT TERMS:
Equity: refers to the right of the owner over the resources of the firm after deducting the claims of
creditors.
Equity accounts: used by the firm will vary depending on the form of business organization.
Capital: the account title usually used for sole proprietorship and partnerships
Stockholders’ equity is the account title used for corporations.
Statement of changes in equity is arrived at by adding the beginning capital, any additional
investments made during the period, net income, and deducting any withdrawals made by the owner
CASH FLOW STATEMENT
Cash is the most commonly used accounting title in the financial statements. This is because (a) when
you pay for a good or services, you pay cash; (b) when you pay a liability or expense, you pay cash; (c)
when you are paid for goods or services, you pay cash; (d) and when your borrower pays what they owe
you, you receive cash. These transactions are common and therefore, cash as an account title is
commonly used. Cash also includes other cash equivalents and short-term investments. For example,
when you purchase an investment that will mature within the next three months from the date of
acquisition, then this shall already be categorized as cash equivalent and may be recorded as cash in
the accounting records.

Cash Basis vs. Accrual Basis Accounting

For us to appreciate the cash flow statement, where cash basis of accounting is being presented, we
would need to understand the difference between the cash basis and accrual basis of accounting.
Accrual basis of accounting is a basic accounting principle that states that income is earned
regardless of when cash is received, and expenses are incurred regardless of when cash is paid. This
means that companies who sell their goods on credit will record the said transactions as sales even if
they have not paid cash. When a firm receives billing for their utilities, they recognize the corresponding
expenses in their records even if they have not paid for it. That is because their products were already
sold and delivered and the expenses already used or incurred. On the other hand, the Cash basis
accounting relies entirely on the payment and receipt of cash. Meaning, income shall only be recognized
when cash is received, and expenses shall only be recorded when cash is paid. This is not acceptable in
the accounting industry though we need to understand this in order to prepare our cash flow statement.

Types of Cash Flows

Cash flows are categorized into three types: operating, investing, and financing activities. These
activities determine the purpose for which the cash has been used. Thus, the purpose of the transaction
shall determine its type of cash flow.
Operating Activities
These are activities related to revenue-producing activities. The transactions falling under these
activities shall primarily involve cash received from customers and paid to suppliers, lenders, or
employees. Before discussing the two other cash flow activities, it is noteworthy to know the two ways
operating activities are presented: Direct and Indirect.
Direct Method
Direct method involves transactions showing those related to gross cash receipts and gross cash
payments. Presentation is as follows:
Among all the activities, only operating activities have different ways of being presented. Most probably
because they are the common transactions happening in the organization.
Investing Activities
These are activities related to the acquisition and disposal of long-term assets like Investments and
Property, Plant and Equipment (PPE).
Financing Activities
These are activities which involve changes in the equity and liability accounts in the accounting records.

Statement of Cash Flows – sample

Basic reconciliation of cash flow and accrual method of accounting

A business that uses accrual-basis accounting can assemble its cash flow statement one of two ways:
using the direct method or the indirect method. The indirect method, which is far more common, involves
reconciling the company's net income with its operational cash flow.
The direct method requires building a cash-flow statement from the ground up, using data from what
might be thousands of individual transactions.
The indirect method, on the other hand, uses information already available on the income statement
and balance sheet. To use the indirect method, you start with your company's net income -- its profit --
for the period covered by the cash flow statement. This figure comes from the income statement for the
period.

Non-Cash Items
In accrual accounting, some things change your profit but don't actually change your cash flow. Other
things have an effect on cash flow but don't actually affect your profit. Reconciling net income and
operational cash flow involves adding or subtracting such items based on whether they affected profit or
cash flow. The first step here is to add up all non-cash expenses you reported during the period.
Depreciation and amortization are examples of non-cash expenses. Because they were reported as
expenses, they reduced net income as shown on the income statement, but they had no effect on cash
flow. Write this figure down.
Current Assets
Current assets include inventory, accounts receivable and prepaid expenses. When a current asset
increases, it reduces operational cash flow in relation to net income. For example, if an item is in
inventory that means you've laid out cash for it. But because you haven't sold it yet, you haven't reported
its cost as an expense -- and therefore, its cost hasn't changed net income. That needs to be reconciled.
For each category of current assets (except cash), take the figure from the balance sheet at the
beginning of the period and the figure from the balance sheet at the end. Subtract the beginning figure
from the ending figure. That's the period change for that particular current asset. Do this for all
categories of current assets.
Current Liabilities
Current liabilities on the balance sheet include accounts payable and expenses such as wages and rent
that have accrued -- that is, they've been incurred and reported -- but have not been paid in cash.
Current liabilities have the opposite effect on cash flow as current assets. When a current liability
increases, cash flow goes up relative to net income. For example, as workers earn wages, you report
what they earn as an expense, which reduces net income. But until you actually issue pay checks,
wages don't affect cash flow. Calculate the period change in each category of current liabilities the same
way you did for current assets -- by subtracting the beginning figure from the ending figure.
Reconciliation
To do the reconciliation, start with net income. Add the total value of non-cash expenses. Then subtract
the period change in each category of current asset. Next add the period change in each category of
current liabilities. (Some of these period changes might be negative. Subtracting a negative change has
the effect of increasing cash flow; adding a negative change has the effect of decreasing it.) The result is
your reconciled cash flow from operations. Add to this figure your net cash flow from investment
activities and financing activities and your cash flow statement is complete.

IMPORTANT TERMS:
Cash: the legal tender being used in exchange for a good, debt, or service.
Cash equivalents: short-term investments with a maturity of, for example, less than three
months.
Operating activities: may be presented using direct method or indirect method.
Accrual basis of accounting: the principle that states that income is earned regardless of
when cash is received and expenses are recognized when incurred regardless of when cash
is paid.
Cash flow Statement: is the financial statement that details the movement of cash in the
business.
Liquidity: is the ability of an entity to pay its liabilities in a timely manner, as they come
due for payment under their original payment terms. Having a large amount of cash and
current assets on hand is considered evidence of a high level of liquidity. When applied to
an individual asset, liquidity refers to the ability to convert the asset into cash on short
notice and at a minimal discount.