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How to Use Financial Statements and Ratios

Posted in 2. Double Entry Transactions,5. Financial Statements,6. Operations by Erin Lawlor on the September 24th, 2008

<< Accounting System Structure – Quick Reference

This post talks about how to make use of the information in Financial Statements.  Those statements are really the results of past operations.  It is important to use this information to be proactive and look to the future to predict results and to set goals, expectations and budgets based on the evidence provided from the past.

Time analysis is the most important tool you will use in analyzing your Financial Statements.  It is essential in managing and securing resources because it can quickly pinpoint changes that indicate errors or fraud as well as the unexpected changes that might require adjustments to cash planning and/or operations.

The first Statement to look at is the Comparison Trial Balance.  This Statement is very important, it shows the amounts posted to each account month by month complete with totals at the end.  The month to month analysis is extremely important for verifying your numbers before you start with ratio analysis.

You can either show all accounts on this Statement or you can limit it to Income Statement Accounts. I choose to include both types of Accounts so I can track the changes in Financial Position provided by the Balance Sheet Accounts.

I’ve added a few entries to the Comparison Trial Balance Report from posts # 7 and 9.   You can see that the monthly changes in Rent Expense for Oct and Nov will catch your attention.

Account Description Jun Jul Aug Sept Oct Nov Dec Total
1000 Checking -$3,000 $-3,000 $-3,000 -$3,000 -$3,000 -$3,000 -$3,000 $-21,000
2000 Accounts Payable $0 $0 $0 $0 -$3,000 $3,000 $0.
7000 Rent $3,000 $3,000 $3,000 $3,000 $6,000 $0 $3000 $21,000
Totals $0 $0 $0 $0 $0 $0 $0 $0

**This example starts with June because of space limitations here.  The additional entries for all months except September are not included in the Income Statement or Balance Sheet, I’ve only added them here for illustration.

Let’s start with Financial Ratios by looking at the Income Statement and its ratios.

Income Statement:

The Income Statement gives you a good overview of your Expenses in relation to your Revenue.  It can also help to pinpoint potential problems.

As the dollar value of Sales changes, the dollar values of Costs of Goods and Expenses should also change.   By tracking the changes in dollar values in terms of percentages of sales, you can more easily evaluate whether changes in dollar amounts are reasonable.

The percentages are based on a Percentage of Sales.  So, Gross Profit Margin = Gross Margin/Sales, Net Profit Margin = Net Income(Profit)/Sales etc.

Know your percentages. Watch your trends over time, both as they accumulate throughout the fiscal year, and as they compare month to month and year to year. Percentages can also be compared to industry ratio standards to measure your results against others in your industry.

Some expenses like wages and payroll taxes, or general office expenses are more meaningful when grouped together to find a percentage of the group rather than as a single line item.

This is the Income Statement that developed through the progressive post entries.

Income Statement % of Sales
Sales $50,000
Cost of Goods Sold $0 0%
————
Gross Margin $50,000 100% Gross Profit Margin %
Rent $3,000 6%
Office Supplies $150
Subscriptions $300
Utilities $125
Fuel $275
Repairs & Maintenance $500
Credit Card Interest $50
———–
Operating Expenses $4,400 9%
———–
Operating Income $45,600 91% Operating Profit Margin %
Other Revenues and Expenses $0
Net Income $45,600 91% Net Profit Margin %

This is a very limited Income Statement Example built from very few entries, but even with the information available, it gives useful information.  There is also obviously a problem with this Income Statement, it has no Cost of Goods Sold to relate to Sales.  In this case, we’re either missing information or we’re violating the Revenue Principle and recording Sales before they’ve been earned.  (Pinpointed Problem)

Gross Margin is also called Gross Profit or even Gross Profit Margin and the terms Income and Profit are also often used interchangeably.  Just be consistent in your terminology so that users will not be wondering if there is a difference in meaning if you use a different term.

**Comparing your business against other businesses in your industry is called Benchmarking.  There are a number of free or fee based benchmarking services online.

Remember that the Income Statement is a Yearly Statement, all its accounts are reset to zero at the end of each year and the difference (Net Income) is transferred to the Equity section of the Balance Sheet as either Retained Earnings (for Corporations) or as Owners Capital (for all other types of entities).

Balance Sheet Ratios:

The Balance Sheet gives you a good overview of your financial position at any point in time.  The Balance Sheet is not a Yearly Statement, it is a cumulative statement whose accounts retain their balances from the beginning to the end of the entity.

All Assets and Liabilities on the Balance Sheet should contribute to increasing the value of the entity.  If they are not contributing, they might need to be liquidated.

The “Current” sections of the Balance Sheet are important to keep track of because it will be Current Assets which will pay off Current Liabilities, you want to make sure you have at least as many Current Assets as Current Liabilities.  The items in the Current Sections are considered to be the most liquid, that is, they are the most likely to be able to convert to cash at (or close to) their stated value.

Two Assets to pay particular attention to are Accounts Receivable and Inventory.  Receivables are an essential tool in doing business, they finance purchases for your customers but it is important to watch their aging and balances to make sure you are not extending credit to customers who are unable to pay.  Watch Inventory turnover to make sure you that your inventory is selling and that you are not carrying obsolete or otherwise unsellable items.

Purchases that your Vendors finance for you are liabilities called Payables.  Payables and other Liabilities are essential for financing current operations and growth but keep close track of their related interest and fees to make sure their costs do not exceed their benefits.

Balance Sheet
Assets
Current Assets
1000 Checking Account $44,350
Fixed Assets
1500 Office Equipment $1,300
1520 Office Furniture $1,650
————
Total Fixed Assets $2,950
————
Total Assets $47,300
Liabilities and Equity
Current Liabilities
2000 Accounts Payable $1,700
————
Total Liabilities $1,700
Equity
Net Income $45,600
————
Total Liabilities and Equity $47,300

Some important financial ratios to keep track of are:

Current Ratio which is Current Assets/Current Liabilities this ratio should always be at least 1

Quick Ratio = Current Assets – Inventory/Current Liabilities this ratio removes Inventory from Current Assets because Inventory is usually the least liquid of the Current Assets.

The next ratios are approximations, they give you a good idea about what they are measuring.  They are general enough to give you an idea about where to look for trouble items but they are not specific enough to be fool proof.

Inventory Turnover = Sales/Inventories this ratio gives you a rough idea of how many times your inventory is sold and restocked.  Of course, it does not specifically identify inventory items so there may be items that are not selling but it does tell you how well your sales are covering your costs.

Days Sales Outstanding = Receivables/(Sales/360) this ratio gives you a number that represents aging of your receivables.  If your terms are net 30 days and this ratio gives you a number of 45 or more, then it is a good indicator that you should watch your collections carefully.

Fixed Asset Turnover = Sales/Net Fixed Assets (Fixed Assets – Accumulated Depreciation) this ratio provides an idea of how effectively your Fixed assets are contributing to operations.   This ratio can be slightly misleading because Assets are carried at book value rather than market value which might scew this ratio depending on the age of the Assets.

Total Assets Turnover = Sales/Total Assets this ratio provides an idea of how effectively your total assets contribute to operations and increases in entity value.  Although this ratio will have the same problems as the Fixed Asset Turnover ratio both of these ratios are still important to recognize and watch for trends.

As I said at the beginning of this post, know your percentages (ratios) watch them carefully.  You should use them to your advantage for predictions, corrections and budgets for your current and future operations and policies.

© 2008 – 2010 Erin Lawlor

<< Accounting System Structure – Quick Reference

**disclaimer: All information posted on this blog is from my own experience and training. The guidelines I present are general and in my experience, standard practice. I do not write with authority from any Accounting Standards Boards.

Comments Off on How to Use Financial Statements and Ratios

General Ledger Accounts on Financial Reports

Posted in 5. Financial Statements by Erin Lawlor on the September 17th, 2008

<< General Ledger >> Financials – Trial Balance

This Post is a listing of which General Ledger Accounts are used by which Financial Statement.

Trial Balance: All Accounts

Account Description Debits Credits
1000 Checking Account (Cash) $44,350
1200 Accounts Receivable $0
1500 Office Equipment $1,300
1520 Office Furniture $1,650
1590 Accumulated Depreciation $496
2000 Accounts Payable $1,700
4000 Sales $50,000
7000 Rent $3,000
7020 Office Supplies $150
7040 Subscriptions $300
7060 Utilities $125
7100 Fuel $275
7200 Repairs and Maintenance $500
7240 Depreciation Expense $496
7300 Credit Card Interest and Fees $50
Totals $52,196 $52,196

Trial Balance: Income Statement Accounts Only

The Income Statement uses the Accounts for Accounting Types:

  • Income
  • Costs (of goods sold)
  • Expenses
  • Other Income and Expenses
Account Description Debits Credits
4000 Sales $50,000
7000 Rent $3,000
7020 Office Supplies $150
7040 Subscriptions $300
7060 Utilities $125
7100 Fuel $275
7200 Repairs and Maintenance $500
7240 Depreciation Expense $496
7300 Credit Card Interest and Fees $50
Totals $4,896 $50,000
Difference = Net Income $45,104

Trial Balance: Balance Sheet Accounts Only

The Balance Sheet uses Accounts for Accounting Types:

  • Assets
  • Liabilities
  • Owners (Stockholders) Equity

These example accounts do not have beginning balances and no equity contributions.  If there had been equity contributions the equity accounts would also be included in this section of the trial balance.

Account Description Debits Credits
1000 Checking Account $44,350
1200 Accounts Receivable $0
1500 Office Equipment $1,300
1520 Office Furniture $1,650
1590 Accumulated Depreciation $496
2000 Accounts Payable $1,700
Totals $47,300 $2,196
Difference = Net Income $45,104

Statement of Cash Flows: This Statement documents both the change in Cash Position and the change in Financial Position.  The Statement of Cash Flows is essentially a Yearly Balance Sheet with an emphasis on Cash.

Notice that debits and credits are presented in the way that they contribute to cash.  This report might take some adjusting to as the +/- of all debit and credit accounts except Cash are reversed.

Statement of Cash Flows
Cash Flows From Operating Activities
Net Income $45,104
(add back expenses that did not involve cash or cash substitutes)
Depreciation (see Bal Sheet Account 1590) $496
Increase in Payables (see Bal Sheet Account 2000) $1,700
————
Net Cash Provided by Operating Activities $47,300
————
Cash Flows From Investing Activities
Increase in Fixed Assets (see Bal Sheet Accounts 1500 & 1520) -$2,950
————
Net Cash Used by Investing Activities -$2,950
————
Cash Flows From Financing Activities
(no increase in long term liabilities or equity) $0
————
Net Cash Provided by Financing Activities $0
————
Increase in Cash and Cash Equivalents (Net Cash Flow)
$44,350
Cash and Cash Equivalents at Beginning of Year
$0
————
Cash and Cash Equivalents at End of Year (see bal sheet acct 1000) $44,350

© 2008 – 2010 Erin Lawlor

Next up: >> Financials – Trial Balance

<< General Ledger

**disclaimer:  All information posted on this blog is from my own experience and training.  The guidelines I present are general and in my experience, standard practice.  I do not write with authority from any Accounting Standards Boards.

Financials – Statement of Cash Flows

Posted in 5. Financial Statements by Erin Lawlor on the September 13th, 2008

<< Financial Statements – Balance Sheet >> Cost of Goods Sold and Inventory

The Cash Flow Statement (Statement of Cash Flows) provides an overview of the way Funds move through an Entity, how they impact Overall Value and eventually reconcile with Cash Balances and determine Net Cash Flow in any given year.

The Cash Flow Statement is essentially the same as a yearly Balance Sheet – it’s just organized a little bit differently and is more summarized. The Balance Sheet accumulates its amounts from the beginning, the Cash Flow Statement only accumulates its balances over one business year. Since the Balance Sheet Accounts carry their balances from year to year, the Cash Flow Statement presents its amounts as either Increases or Decreases to groups of Accounts throughout the year.

Balance Sheet:

The Balance Sheet uses the three categories: Assets, Liabilities and Equity.  Notice that Cash is listed first and Net Income is listed last.

  • Assets
    • Current Assets (including Cash)
    • Fixed Assets (Net of Accumulated Depreciation)
  • Liabilities
    • Current Liabilities
    • Long Term Liabilities
  • Equity
    • Owners’ Capital (Contributions, Stock and Paid in Capital)
    • Retained Earnings
    • Net Income

Cash Flow Statement:

You’ve heard the term “Bottom Line”  well, that term refers to the end result – the numbers at the bottom of the page.  Since the end result of the Cash Flow Statement is Net Cash, it is at the bottom of the report and everything else on the report funnels down to the bottom to come to the final Net Cash number.

The Cash Flow Statement uses the three categories: Operating, Investing and Financing.  Notice that Net Income is listed first and Cash is listed last.  Opposite from the Balance Sheet.

  • Operating Activities
    • Net Income
    • + Depreciation Expense (+ Increase and -Decrease in Accumulated Depreciation)
    • + Increases in Current Liabilities
    • + Decreases in Current Assets
    • – Increases in Current Assets
    • – Decreases in Current Liabilities
  • Investing Activities
    • + Decreases in Long Term/Fixed Assets (Independent of Accumulated Depreciation)
    • – Increases in Long Term/Fixed Assets (Independent of Accumulated Depreciation)
  • Financing Activities
    • + Increases in Long Term Liabilities/Debt
    • – Decreases in Long Term Liabilities/Debt
    • + Increases in Owners’ Capital
    • – Decreases in Owners’ Capital
    • – Increases in Dividends
  • Cash (Beginning Cash Balance – Net Increase/Decrease = Ending Cash Balance)

The net contribution to cash is summarized for each section and then combined to equal Net Cash Flow. Net Cash Flow is then combined with the Beginning Cash Balance to reconcile to the Ending Cash Balance for the year. Net Cash Flow is the difference between the Beginning and Ending Cash Balances.

The Cash Flow Statement is an important indicator of available cash for operations but also of how an entity is generating cash, if it is able to sustain itself and its growth through its operations or if it generated cash through increased debt and equity and/or decreased capital assets.

Statement of Cash Flows (Including Depreciation Entries from Balance Sheet Post)

Statement of Cash Flows
Cash Flows From Operating Activities
Net Income $45,104
Depreciation $496
Increase in Payables $1,700
————
Net Cash Provided by Operating Activities $47,300
————
Cash Flows From Investing Activities
Increase in Fixed Assets $2,950
————
Net Cash Used by Investing Activities -$2,950
————
Cash Flows From Financing Activities
$0
————
Net Cash Provided by Financing Activities $0
————
Increase in Cash and Cash Equivalents (Net Cash Flow)
$44,350
Cash and Cash Equivalents at Beginning of Year $0
————
Cash and Cash Equivalents at End of Year $44,350

© 2008 – 2010 Erin Lawlor

Next up: >> Cost of Goods Sold and Inventory

<< Financial Statements – Balance Sheet

**disclaimer: All information posted on this blog is from my own experience and training. The guidelines I present are general and in my experience, standard practice. I do not write with authority from any Accounting Standards Boards.

Financial Statements – Balance Sheet

Posted in 5. Financial Statements by Erin Lawlor on the September 8th, 2008

<< Financial Statements – Income Statement >> Financial Statements – Statement of Cash Flows

The Balance Sheet is the financial statement that summarizes the value of an entity’s resources and the claims on those resources at any given time. Balance Sheet accounts start accumulating their balances from the beginning of the entity and continue until the end. This contrasts with the Income Statement whose accounts are reset to zero at the end of each fiscal (business) year.

The Accounting Types reported on the Balance Sheet are:

Assets – Assets are items of value that are owned by the business and their value is expected to last beyond the current fiscal (business) year.

Liabilities are essentially debts, they are agreements to delay payments and so, are sources of funds because they provide a way to acquire or pay for goods and services without a direct transfer of cash at the time of the exchange.

Equity (Owners Equity) is a source of funds through direct owner investment (stock or owners capital accounts or owner “re-investment” (retained earnings) when some or all of the income from the previous year is retained by the business rather than distributing it to the owners.

The Balance sheet Equity Section refers to Total Equity which is Owners Equity + Net Income. The Net Income portion is easily calculated because since the total debits and total credits of all financial accounts must be equal, and the Balance Sheet and Income Statement split the Accounts between them. The difference between the Balance Sheet Accounts will equal the difference between the Income Statement Accounts – which is Net Income.

Since Owners Equity is only part of Total Equity, Net Income can also be calculated using a rewrite of the Accounting Equation:

  • From: Assets = Liabilities + Equity
  • To: Assets – Liabilities = Total Equity (Owners Equity + Net Income)

Move Owners Equity to the other side of the equation as well and the equation becomes:

  • Assets – Liabilities – Owners Equity = Net Income  – or –
  • Net Income = Assets – Liabilities – Owners Equity

Balance Sheet Draft:

The Balance Sheet does not contain any of the same accounts as the Income Statement, but it does summarize the Income Statement on one line called “Net Income” that is inserted (without an account #) at the end of the Equity Section of each Balance Sheet. The Net Income entry completes the Accounting Equation for the Balance Sheet: Assets = Liabilities + (Total) Equity (Owners Equity + Net Income)

So, the listing of balance sheet accounts from the Income Statement post gives us a start in creating a Balance Sheet prior to year end closing entries.

Account Description Debits Credits
1000 Checking Account $44,350
1200 Accounts Receivable $0
1500 Office Equipment $1,300
1520 Office Furniture $1,650
2000 Accounts Payable $1,700
Totals $47,300 $1,700

The Balance Sheet has a section for each of the elements of the Accounting Equation, Assets, Liabilities and Equity. It also divides Assets and Liabilities into Current and Long Term (or Fixed Asset) sections. The “Current” sections contain accounts for Assets and Liabilities that are expected to convert to cash within one year.

Current Liabilities are the claims on Current Assets the information from these Sections provide the information for two important financial ratios that help to determine if the business is able to fulfill its short term obligations.

  • Current Ratio = Current Assets/Current Liabilities
    • A Current Ratio of at least 1:1 (or >= 1) indicate that there is at least one dollar of current assets for each dollar of debt.
  • Quick Ratio = Current Assets – Inventory/Current Liabilities
    • A Quick Ratio of at least 1:1 indicates that there is at least one dollar of cash or cash equivalent (including accounts receivable) for each dollar of debt.

Balance Sheet Format:

To convert the account listing above to a Balance Sheet format, I’ll add some section headings and a line for the Net Income from the previous Income Statement post.

Balance Sheet
Assets
Current Assets
1000 Checking Account $44,350
Fixed Assets
1500 Office Equipment $1,300
1520 Office Furniture $1,650
————
Total Fixed Assets $2,950
————
Total Assets $47,300
Liabilities and Equity
Current Liabilities
2000 Accounts Payable $1,700
————
Total Liabilities $1,700
Equity
Net Income $45,600
————
Total Liabilities and Equity $47,300

Assets = Liabilities + Equity. The the first thing I check when I read a Balance Sheet is whether it is “in balance”/the accounting equation is true. Once I know it balances, I can focus on the substance of the report.

Notice that the Net Income entry doesn’t have an account number beside it. Net Income does not have an account, it is the difference between the Balance Sheet Accounts. It is also the difference between the Income Statement Accounts.

Book Values:

Each item on the Balance Sheet is stated at its original value or cost. Since the accounts accumulate their balances from “the beginning of time”, each balance sheet item also stays there at its original value until it is sold, written off or satisfied (debts paid off or equity repurchased).

Items that are listed on the Balance Sheet do lose their value over time so instead of reducing their original account values, contra accounts are used to write down, depreciate or amortize them. Contra Accounts are the same Accounting Type as their counterparts but if their counterpart is a debit account, the contra account is a credit account. The Net Value of the Original Account and the Contra Account together reflects the decrease in book value without losing the historical value. Contra Accounts like Accumulated Depreciation prevent items from “falling off” the Balance Sheet while they are still owned by the entity because when the item’s value eventually depreciates to zero, it is still part of the original account balance.

Depreciation is determined by type of fixed asset. Depreciation methods, classes of assets and examples are listed in IRS Publication 946. Sometimes entities use different depreciation methods for book/tax purposes. Always ask a tax professional for guidance in making decisions that have tax implications.

The purpose of this entry is to demonstrate basic depreciation entries rather than depreciation calculations. I will use straight-line depreciation and assume that the assets were put into service on January 1st. Publication 946 (pg 31) indicates that office equipment is depreciated over 5 years and office furniture is depreciated over 7 years. For the depreciation entry I will add a contra asset account and a depreciation expense account.

Account Description Debits Credits
7240 Depreciation Expense $496
1590 Accumulated Depreciation (Office Equipment) $260
1590 Accumulated Deprectiation (Office Furniture) $236

Balance Sheet After Closing Entries:

At the end of each year when the Income Statement accounts are reset to zero, the difference between their debit and credit balances (Net Income/(Loss)) is posted to a Balance Sheet Equity account called Retained Earnings (for corporations or Owners’ Capital for other types of organizations). An example of this entry can be found at the end of the Income Statement post.

After the depreciation entry above, expenses were increased and net income was decreased by $496. After the depreciation entry is appended to the closing entries to the Income Statement, our Balance Sheet looks like this. Note the change from Net Income with no account number to Retained Earnings with the account number 3500. The entry to account 3500 is is part of the year end income statement accounts closing entry.

Balance Sheet
Assets
Current Assets
1000 Checking Account $44,350
————
Total Current Assets $44,350
————
Fixed Assets
1500 Office Equipment $1,300
1520 Office Furniture $1,650
1590 Accum. Depreciation $-496
————
Total Fixed Assets $2,454
————
Total Assets $46,804
Liabilities and Equity
Current Liabilities
2000 Accounts Payable $1,700
————
Total Liabilities $1,700
————
Equity
3500 Retained Earnings $45,104
————
Total Equity $45,104
————
Total Liabilities and Equity $46,804

© 2008- 2010 Erin Lawlor

Next up: >> Financial Statements – Statement of Cash Flows

<< Financial Statements – Income Statement

**disclaimer: All information posted on this blog is from my own experience and training. The guidelines I present are general and in my experience, standard practice. I do not write with authority from any Accounting Standards Boards.

Financial Statements – Income Statement

Posted in 5. Financial Statements by Erin Lawlor on the September 5th, 2008

<< Financial Statements – Trial Balance >>Financial Statements – Balance Sheet

One of the Principles of GAAP is the Matching Principle.  Matching requires that when you post sales into the system for an accounting period (month), you must also post the costs of the products or services you sold during that period in the same accounting period (month). The Matching Principle essential to Financial Statements, particularly the Income Statement, because it makes them meaningful.

The Income Statement, also called the P&L or Profit and Loss Statement, is a “Current Year” statement, it does not cross years. The Income Statement provides cumulative “To Date” financial data for the current business (Fiscal) year. So, the March Income Statement shows the totals for January, February and March together in one column and the totals for the previous December would not be part of the totals for that column.

Unlike the Trial Balance, the Income Statement and Balance Sheet each only show a portion of the General Ledger Accounts. The GL Accounts are split between the Income Statement and the Balance Sheet by their Accounting Types. The Income Statement Accounting Types are Revenue, Cost of Goods Sold and Expenses. The Accounts that are not on the Income Statement are on the Balance Sheet.

As its name suggests, the purpose of the Income Statement is to report Income. Income = Revenue – Expenses. It is almost that simple, but there is more to the Income Statement than a simple calculation.

The format for the Income Statement is:

Revenue
Cost of Goods Sold
—————-
= Gross Margin
Expenses
—————-
= Operating Income
+ Other Revenue
Other Expenses
—————-
= Net Income

The Income Statement uses intermediate steps to reach Net Income. The first of these steps is Gross Margin.  Gross Margin = Revenue – Cost of Goods Sold and represents the amount of revenue that is left after costs to cover operating expenses. Gross Margin is meaningful because it shows the direct relationship between the costs of products or services and their sales.

The Gross Margin % can be compared to industry standards to make sure your pricing and costs are competitive. It is calculated as:

  • Gross Margin = Revenue – Cost of Goods Sold
  • Gross Margin % = Gross Margin ($) / Revenue

The next intermediate step towards Net Income is Operating Income. Operating Income = Gross Margin – Expenses and is the amount of profit (income) from normal (usual) operations.

The final step in calculating Net Income is to add the amounts for the Accounts categorized as “Other Revenue” and to subtract the amounts for the Accounts categorized as “Other Expenses”. Other Revenues include any “money in” (gain) that is not received from the sale of the usual business products or services, this might be a gain on the sale of an asset like a vehicle. Other Expenses include any “money out” (loss or expense) that is not part of the usual expenses or cost of goods sold. Other Expenses might include some interest charges or a loss on the sale of an asset.

Income Statement
Sales $50,000
Cost of Goods Sold $0
————
Gross Margin $50,000
Rent $3,000
Office Supplies $150
Subscriptions $300
Utilities $125
Fuel $275
Repairs & Maintenance $500
Credit Card Interest 50
———–
Operating Income $45,600
Other Revenues and Expenses $0
Net Income $45,600

This Income Statement is produced from the transactions that have been posted in previous posts.  The presence of sales but no costs on this Income Statement indicate that either my entries for the period are incomplete or I’ve violated the matching principle because if I have sales, I must have some associated costs.

Net Income is the amount of revenue that was not spent on operations, it represents the amount of the increase in overall value.  Remember not to confuse the terms Revenue or Income with Cash. The Net Income amount here is $45,600 and if you check the Trial Balance from the previous post, the Checking Account Balance is $44,350.

Let’s look at the Income Statement again in terms of debits and credits.

Account Description Debits Credits
4000 Sales $50,000
7000 Rent $3,000
7020 Office Supplies $150
7040 Subscriptions $300
7060 Utilities $125
7100 Fuel $275
7200 Repairs and Maintenance $500
7300 Credit Card Interest and Fees $50
Totals $4,400 $50,000

Remember from the Trial Balance report which shows all accounts and their balances that the total debit amounts were equal to the total credit amounts.  The Income Statement splits the accounts with the Balance Sheet and so the total debits and total credits on each of these statements will not be equal, but the debits and credits of their combined accounts are equal.  So, let’s take a look at the Accounts that are not listed on the Income Statement.

Account Description Debits Credits
1000 Checking Account $44,350
1200 Accounts Receivable $0
1500 Office Equipment $1,300
1520 Office Furniture $1,650
2000 Accounts Payable $1,700
Totals $47,300 $1,700

The difference between the balances of the Income Statement Accounts, $45,600, is equal to the difference between the Balance Sheet Account balances.  This listing of the Balance Sheet Accounts shows where the Net Income went.  $47,300 increase in assets – money still due $1,700 = $45,600 = Net Income of $45,600.

The Income Statement Accounts accumulate their balances throughout the fiscal year and at the end of the year, the accounts are reset to zero (closed out) and the difference between their total debits and total credits (Net Income) is transferred to the Balance Sheet. The Balance Sheet account used in the transaction is an Equity account and is either Retained Earnings or Owners Capital depending on the structure of the business.

Closing Entries:
The entry to close out the year for the Income Statement Accounts in our examples is:

Account Description Debits Credits
4000 Sales $50,000
3500 Retained Earnings $45,600
7000 Rent $3,000
7020 Office Supplies $150
7040 Subscriptions $300
7060 Utilities $125
7100 Fuel $275
7200 Repairs and Maintenance $500
7300 Credit Card Interest and Fees $50
Totals $50,000 $50,000

© 2008 – 2010 Erin Lawlor

Next up: >>Financial Statements – Balance Sheet

<< Financial Statements – Trial Balance

**disclaimer: All information posted on this blog is from my own experience and training. The guidelines I present are general and in my experience, standard practice. I do not write with authority from any Accounting Standards Boards.

Financial Statements – Trial Balance

Posted in 5. Financial Statements by Erin Lawlor on the September 5th, 2008

<< General Ledger – Accounting Periods >>Financial Statements – Income Statement

I decided to skip ahead a little and introduce the financial statements.  We’ve covered the basics well enough to make sense of them so for now, let’s stick to the subject of the Payoff and go back to cover the details of subledgers and month ends in future posts.

The General Ledger takes the information from transactions and summarizes it by Account and by Accounting Period.  The four basic Financial Statements present General Ledger (GL) Accounts and their balances by specific date ranges, usually accounting periods. The four basic financial statements are:

In this Post, I’ll introduce the most basic and simple of the statements -The Trial Balance.

The Trial Balance is a listing of all General Ledger (GL) Accounts and their balances at any given time in order of GL Account Number.  It is often used as a quick check of a balance and also as a worksheet for adjusting entries.  One of the advantages of this report is that it contains *all* accounts and their balances from the General Ledger.

The Trial Balance is different from the other Financial Statements because it is the only one that lists all Accounts, the Income Statement and the Balance Sheet split the Accounts and the Cash Flow Statement uses the same Accounts as the Balance Sheet.

The Standard Trial Balance is straight forward and doesn’t require any further explanation. It is a quick report that can be printed or viewed to check the balance of specific accounts and to make sure that the books are in balance – that debits = credits.

The Comparison Trial Balance is also straight forward and provides the same information as the standard version but it gives balances both by account and by accounting period. Time analysis is essential in managing and securing resources because it can quickly pinpoint changes that indicate errors or fraud as well as the unexpected changes that might require adjustments to cash planning and/or operations.

We have already seen both versions of the Trial Balance and I’ll reprint them here for review.

Standard Trial Balance as seen in Post #4 (with Account Numbers that were added in Post #5)

Account Description Debits Credits
1000 Checking Account $44,350
1200 Accounts Receivable $0
1500 Office Equipment $1,300
1520 Office Furniture $1,650
2000 Accounts Payable $1,700
4000 Sales $50,000
7000 Rent $3,000
7020 Office Supplies $150
7040 Subscriptions $300
7060 Utilities $125
7100 Fuel $275
7200 Repairs and Maintenance $500
7300 Credit Card Interest and Fees $50
Totals $51,700 $51,700

This is the Comparison Trial Balance Report from post # 7

Account Description Jun Jul Aug Sept Oct Nov Dec Total
1000 Checking $0 $0 $0 -$3,000 $0 $0 $0 $-3,000
….. ……….
7000 Rent $0 $0 $0 $3,000 $0 $0 $0 $3,000
Totals $0 $0 $0 $0 $0 $0 $0 $0

**This example starts with June because of space limitations here.

© 2008 – 2010 Erin Lawlor

Next Up: >>Financial Statements – Income Statement

<< General Ledger – Accounting Periods

**disclaimer: All information posted on this blog is from my own experience and training. The guidelines I present are general and in my experience, standard practice. I do not write with authority from any Accounting Standards Boards.