Key Financial Statements: Income, Balance Sheet, Cash Flow
Key Financial Statements
The Income Statement
Also known as the profit and loss account, the profit statement, the income and expenditure statement, or the receipts and payments account.
The Balance Sheet
Also known as the statement of financial position.
The Cash Flow Statement
Shows what cash came in and what cash went out over a period of time.
- Two accounting elements which appear in the income statement:
- Expenses
- Income
- Three accounting elements which appear in the balance sheet:
- Assets
- Liabilities
- Equity
The Income Statement
- It reports on certain financial aspects of transactions that have taken place during the accounting period that has just finished.
- It does so by showing what income has been earned and what expenses were incurred in earning it.
- If the income is larger than the expenses, then it becomes a profit.
- If the expenses are greater than the income, then it becomes a loss.
Revenue
- Revenue could also be called income or sales.
- The income is what is earned for working for that period of time.
- The cost of the components used, not the cost of the components purchased in the period.
- Gross profit is a heading used in the income statement to show the profit from activities before the remainder of the costs of running the business are deducted.
Expenses
- Expenses cover the indirect costs of producing this period’s income.
- Transport costs are a standard heading in many accounts.
- Marketing costs are costs spent on advertising, etc.
- Administration costs are costs used for all the other costs.
- Net Profit: What is left of the income after all the costs related to it have been allowed for. If the costs are greater than income, then there would be a loss rather than a profit.
The Balance Sheet
The balance sheet shows the financial position at a point in time, as one accounting period ends and another one starts.
Three main elements of the balance sheet:
- Assets
- Liabilities
- Equity
The Cash Flow Statement
A cash flow statement is also known as the statement of cash flows or funds flow statement.
It is a financial statement showing how changes in balance sheet accounts and income affect the cash flow.
The cash flow statement is concerned with the flow of cash in and out of an organization.
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.
Cash-Based Accounting
- Cash accounting is what is done to work out the balance in the cash till or bank account of a business. It involves a comparison between what has gone in and what has gone out over the period of time since the balance was last calculated.
- Revenue is recognized when cash is received.
- Expenses are recognized when cash payments are made.
- Advantage: It is easy to implement. Under this method, the only time a transaction is recorded is when cash is paid or received.
- Disadvantage: It does not fully describe the financial position of the business or person.
Accrual-Based Accounting
- It means that income includes everything earned by the business for a particular period, whether it has yet been received in cash or not. It also means that expenses include everything incurred by the business during that period, whether it has yet been paid or not.
- Revenue is recognized in the period in which it is earned rather than when cash is received.
- Expenses are recognized in the period in which they are incurred (i.e., contribute to the generation of revenue) rather than when cash is paid.
- Advantage: The accrual basis of accounting becomes the more appropriate basis when the organization has substantial unpaid bills or uncollected income at the end of each period, and these amounts vary from period to period.
- Disadvantage: The accrual system, a more complex system, requires more accounts, including accounts receivable, accounts payable, inventory, prepaid expenses, and deferred revenue.