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1. THREE IMPORTANT FINANCIAL STATEMENTS
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INTRODUCTION TO FINANCIAL STATEMENTS
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Financial
statements are of prime importance to any
business owner or manager.
Accurate and
comprehensive maintenance of the bookkeeping
system facilitates timely preparation of Financial
Statements. These statements consist of three important documents and are
designed to provide an updated information regarding
a company's solvency, profitability
and liquidity, as illustrated below.
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THREE IMPORTANT FINANCIAL STATEMENTS
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Balance
Sheet
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Income
Statement
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Statement
Of Cash Flows
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A balance sheet provides information about
a company's solvency, i.e. the
excess of its assets over its liabilities
at a specific moment of time.
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Income statement provides information about
a company's profitability, i.e.
the excess of its revenues over its expenses
during a specific period.
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A statement of cash flows provides information
about a company's liquidity,
i.e. the excess of its available and incoming
funds over its outgoing funds during a specific
period.
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2.
BALANCE SHEET
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BALANCE
SHEET
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A Balance Sheet
is a statement of the company's
financial position at a specific moment in time. Balance
sheet is referred to as a "snapshot"
of the organization's resources and obligations
and is intended to describe the financial condition
of the company on the date of closing books
of account.
The resources,
or Assets, available to management are
classified into four categories. The
obligations, or claims, against these assets
are made by creditors and shareholders and are
classified as the company's Liabilities and
Shareholders' Equity.
A balance sheet
merely summarizes the financial position and
provides details of all assets and liabilities
of the organization at a given date. It
does not indicate whether the company makes
profit or incurs losses. A simplified example
of a balance sheet is presented below.
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CLASSIFICATION
OF ASSETS
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No.
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Details
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1
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Current Assets.
Current
assets include cash, accounts receivable,
inventory (merchandise, direct materials,
work-in-process, and finished goods), receivables,
prepaid expenses, refundable deposits, and
short-term investments.
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2
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Capital Assets.
Capital
assets, also known as Fixed Assets
or Long-Term Assets, include land,
buildings, equipment, furniture, and vehicles
purchased for use.
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3
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Long-Term Investments.
Long-term
investments include land, buildings,
or equipment purchased for speculative
reasons.
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4
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Intangible Assets.
Intangible assets include patents, copyrights,
trademarks, and goodwill.
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CLASSIFICATION
OF LIABILITIES AND SHAREHOLDERS' EQUITY
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No.
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Details
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1
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Current Liabilities.
Current liabilities include accounts payable,
bank overdraft (used up credit line), current
portion of a long-term debt, dividends payable,
notes payable, payroll liability, taxes
payable, product warranty liability, and other
accrued liabilities.
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2
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Long-Term Liabilities.
Long-term liabilities include bonds payable,
capital leases, mortgages payable, and
pension liability.
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3
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Shareholders' Equity.
Shareholders' equity includes the value of
the issued stock and retained earnings.
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3.
WHAT IS AN ACCOUNTING PERIOD?
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WHAT IS AN ACCOUNTING PERIOD?
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All financial statements are usually drawn on
a regular basis covering a particular period
of the company's operating activities. This
period is termed the Accounting Period
and represents an important milestone in the
company's life.
The length of the accounting period
is commonly accepted as one full year, known
as the Fiscal Year or Financial Year.
Management has the option of selecting
the beginning of the company's fiscal year in
accordance with the particular operating conditions
and other relevant factors.
Sometimes financial statements may be drawn
up on semi-annually, quarterly or monthly basis,
depending upon the specific requirements of
the shareholders, management and outside creditors.
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4.
SMALL BUSINESS EXAMPLE:
BALANCE SHEET
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5.
INCOME STATEMENT
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INCOME STATEMENT
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Income Statement
summarizes the
amounts of operating revenues earned and operating
expenses incurred during a specific accounting
period.
The prime result of an income statement
is the determination of Gross Margin From
Sales (for merchandising and manufacturing
companies) and Net Income, i.e. Net
Profit (before and after taxes).
The final presentation
form of revenues, expenses, and net income depends
upon the nature of the company's operating activities.
This is reflected in three different forms
of income statement, as illustrated below.
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THREE
FORMS OF AN INCOME STATEMENT
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Income
Statement
For
A Service
Company
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Income
Statement
For
A Merchandising
Company
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Statement
Of Cost
Of Goods
Manufactured
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Income Statement
For
A Manufacturing
Company
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OPERATING
REVENUES AND EXPENSES
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Operating Revenues include all amounts
earned by the company as a result of rendering
services or selling goods to customers during
the accounting period, while Operating Expenses
include all costs incurred by the company
during the same period.
Operating expenses for manufacturing
companies are also known as Manufacturing
Costs.
An illustration
of a typical Income Statement for a service
company is presented below.
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6.
SMALL BUSINESS EXAMPLE:
INCOME STATEMENT
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7.
CLASSIFICATION OF INVENTORY FOR ACCOUNTING PURPOSES
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INVENTORY VALUES
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The income statement contains detailed information
pertaining to the Value Of Inventory
carried by the organization during a particular
accounting period.
The Classification Of Inventory also depends
upon the nature of the company's activities,
as illustrated below.
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CLASSIFICATION
OF INVENTORY
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Service
Company
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Merchandising
Company
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Manufacturing
Company
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A service company usually does not
carry inventory except for certain consumable
items, e.g. supplies, or spare parts.
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A merchandising company carries inventory
for resale known as Merchandise Inventory.
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A manufacturing company carries three types
of inventory:
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Direct
Materials Inventory.
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Work-In-Process
Inventory.
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Finished
Goods Inventory.
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8.
STATEMENT OF COST OF GOODS MANUFACTURED
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STATEMENT
OF COST OF GOODS MANUFACTURED
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Additional
information pertinent only to manufacturing
companies is included in the Statement
Of Cost Of Goods Manufactured.
The main purpose
of this statement is to summarize all manufacturing
costs incurred during a specific accounting
period and to establish the cost of goods manufactured.
This information is essential to the process
of determining the income for a manufacturing
company.
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9.
ANNUAL INCOME STATEMENT
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ANNUAL
INCOME STATEMENT
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Income statement, or Profit And Loss Account
(P & L Account), is usually computed
on a monthly basis to ensure sufficient control
over the company's operating activities.
The statement summarizing twelve month of the
company's performance is termed the Annual
Income Statement and represents the second
important financial statement.
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10.
STATEMENT OF CASH FLOWS
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CASH FLOW
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Each financial
statement provides essential information pertinent
to the company's activities during the specified
accounting period. The Balance Sheet,
for example, illustrates at a point in time
the assets and liabilities of the company. The
Income Statement, on the other hand,
summarizes the results of the company's operating
performance during the accounting period.
There
are, however, certain important issues that
are not addressed by these financial statements.
These issues relate to the actual Flow Of
Cash into and from the organization during
the accounting period. It may be necessary,
for example, to identify whether the company
generated a Positive Cash Flow or a Negative
Cash Flow as a result of its operating
activities and whether investing and financing
activities yield or consume cash.
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Positive
Cash Flow
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Negative
Cash Flow
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Positive cash flow signifies that the company
received, but not necessarily earned,
more cash than it has issued during a particular
accounting period.
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Negative cash flow, conversely, means that
the company issued, but not necessarily
spent, more cash than it has received
during the same period.
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CASH FLOW ACTIVITIES
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The company may be involved in various activities
apart of providing services, purchasing merchandise
for resale, or manufacturing goods for sale
to customers.
Furthermore,
the company may also purchase capital assets,
such as machinery and equipment for operational
use, or a piece of land for investment purposes,
or it may repay a debt to one of its creditors.
All
such activities should be classified either
as Operating Activities, Investing
Activities, or Financing Activities,
as illustrated below.
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THREE
TYPES OF CASH FLOW ACTIVITIES
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Operating
Activities
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Investing
Activities
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Financing
Activities
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These activities include transactions that
relate to the determination of net income,
i.e. revenues received from customers, interest
received from investments, manufacturing costs,
operating expenses, interest, and tax expenses.
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These activities include only transactions
that relate to the purchase or sale of capital
assets and marketable securities and advance
or collection of loans to and from borrowers.
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These activities include only transactions
that relate to obtaining and returning funds
from, and to shareholders and creditors.
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STATEMENT
OF CASH FLOWS
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Statement
Of Cash Flows is
the third important financial statement, which
summarizes all receipts and payments of funds
by an organization during a specified accounting
period.
Statement of
cash flows reflects the movement
of funds as a result of all operating, investing,
and financing activities of the organization.
An illustration
of a typical Statement Of Cash Flows is presented
next.
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11.
SMALL BUSINESS EXAMPLE:
STATEMENT OF CASH FLOWS
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12. FOR SERIOUS BUSINESS OWNERS ONLY
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Reprinted
with permission. |
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