I have enjoyed learning about the basics of accounting again. This week I will share more about the items in a balance sheet (or Statement of Financial Position) and an income statement (or Statement of Profit or Loss).
A balance sheet shows a picture of the accounting equation Assets = Owner’s Equity + Liabilities. The balance sheet has two parts of the accounting equation:
Assets and Finance Structure.
Assets: These are things that the company owns and uses to achieve their goals. They can be grouped in different ways:
Non current asset: these are assets that the company will use for more than 12 months. They are not easy to turn into cash in 12 months. For example, buildings, machines, investments. Non current assets can be either tangible or intangible. Tangible assets are things that you can touch, like a machine or a car. Intangible assets are things that you can’t touch, but they still have value, like a brand name, a patent, or goodwill.
Current Asset: these are cash or things that can be turned into cash quickly. The company will use them within 12 months. For example, cash, inventory, prepaid expenses, trade receivables
Owner’s Equity: this is the value of the company after taking away all the debts from the assets. It usually consists of the money that the owners put into the business and the money that the business keeps from its profits.
Share capital: this is the money that the owners put into the business. It is recorded at a fixed value and does not change over time.
Retained earnings: this is the money that the business keeps from its profits. It is the net profit minus the dividend paid. This is the money that the business reinvests into its operations.
Liabilities: these are the debts that the company owes. Like assets, they can be grouped into Non-current and current liabilities.
Non current liability: these are the debts that the company will pay back after more than 12 months. Examples include long term loans, debentures, etc.
Current liability: these are the debts that the company will pay back within 12 months. Examples include accruals, overdrafts, short term loans, trade payables
At the end of the balance sheet, total assets must be equal to total liabilities and owner’s equity. This is what it means to have a balanced sheet. That’s why it is called a balance sheet.
The income statement shows the revenue and expenses of the business.
Revenue: this is the money that the business makes from selling its products and services. Based on the accrual concept, revenue is recorded when it is earned, not when it is paid.
Cost of Goods sold: this is the money that the business spends to make the products and services that it sells. It is calculated by adding the inventory at the beginning of the year to the purchases during the year, and then subtracting the inventory at the end of the year.
Gross profit: this is the money that the business makes after paying for the cost of goods sold.
SG&As: these are the money that the business spends on other things that are not directly related to making the products and services. For example, salaries, rent, advertising, etc.
Net profit: this is the money that the business makes after paying for all the expenses. If the business does not pay any tax, this is the final profit. The business can use this money to pay dividends to the owners or to reinvest into the business.
These are the items of both a balance sheet and an income statement.
Conclusion:
Learning about the balance sheet and the income statement is very useful for understanding the financial situation of a business. The balance sheet shows the assets, liabilities, and owner’s equity of the business at a certain point in time. The income statement shows the revenue, expenses, and net profit of the business over a period of time. By looking at these two statements, we can see how the business is performing and what are the sources and uses of its money. This can help us make better decisions and plan for the future.
