Most important financial statements
“No romance without finance” is part of the lyrics of ’90s hit which point to a major life truth: whatever job you’re doing, sooner or later you are going to review the financial statements. This is inevitable, because the insight into the structure of sources, assets, revenues, expenses and other financial indicators you can learn your position “in space and time ‘, or whether you are doing your job well or not, and where there is room for improvement.
Content of this “recipe” won’t be exclusively finance and accounting. My goal is to show you some simple techniques that can help to manage books and easy assemble financial statements. When it comes to their interpretation you’ll have to put in some work. Nevertheless, where is the will there is the way, and you will also learn something new.
The four most important financial reports (hopefully not the four horsemen of the apocalypse) are:
- Balance Sheet
- Income Statement (Profit & Loss Account)
- Cash Flow
- Statement of Changes in Equity
Balance sheet is a financial statement which shows the status of the assets, as well as equity and liabilities of the company on a certain date, usually the last day of the year.
Income Statement is a financial statement which shows data on revenues, expenditures and business results of the company (profit or loss) in given time period.
Statement of cash flows is a financial report that shows the cash flows of a company (inflows and outflows) based on the business activities, investing activities and financing in a period of time.
Statement of retained earnings is a financial statement which shows changes (increase and decrease) of own capital of a company in given time period.
Text that follows will explain how to create a Balance Sheet and Income Statement.
Both of these reports are assembled on basis of data within Ledger Journal, which is simply a table in which we chronologically entering financial changes and account numbers they address to. Journal is usually consisted of: serial number, date, short description of a financial change, account number, amount of incomes and outflows of money.
All changes are addressed to accounts. Account number is consisted of multiple digits (3-6) and it holds information necessary to know the nature of a change, whether it is an income, cost, register account, byers or vendors account…
There’s a saying: “If you see a man on the street who talks to himself he is crazy, or renovating his flat, or he is an accountant.” Proverbially, accountants have their own “circle of trust” and the vocabulary that you need to learn if you want to understand them, and it is based on Chart of accounts. The chart of accounts is a codebook prescribed by the state, which briefly indicates which changes are addressed to which accounts. When you’re entering financial changes into a journal you you must comply with the Chart of accounts.
The balance sheet consists of two main parts: assets and liabilities. Assets, which are usually recorded on the left side of the report, are list of all corporate assets (fixed assets, working capital). Liabilities, which are recorded on the right side, contains data on the sources of funds, which may be liabilities (suppliers, short-term and long-term loans) and equity (share capital, profits, retained earnings). Balance Sheet is filled by entering formulas on positions in accordance of assets and liabilities. These are calculations based on SUMIFS function, which arguments are periods, amounts and account numbers. For example, a byers account is shown on the left side of the report, as the assets position. The value of this account is calculated by a formula where you enter, using the SUMIFS function, all the inflows and outflows regarding byers for a certain period, usually within one calendar year. The process is repeated for all other positions. At the end totals of assets and liabilities must be equal (or we did something wrong).
Income Statement also has a simple, prescribed form. First we calculate Sales from which we subtract COGS (Cost of Goods Sold). The result is gross profit (Gross Margin). When we subtract OPEX (Operative Expenses) from Gross Margin we get E.B.I.T.D.A, which is short of Earnings Before Interests, Taxes, Depreciation and Amortization. Further when we subtract interests, taxes, depreciation and amortization we get Net Profit, as a total of this financial report. All positions are calculated by using SUMIFS function, by adding the inflows and outflows on accounts in certain period, similar to when we made the Balance Sheet.