Financial Accounting Basics: Part 1 – Getting Started
Financial Accounting Basics: Part 2 – Double Entry Accounting
Financial Accounting Basics: Part 3 – Post to the General Ledger
Financial Accounting Basics: Part 4 – Unadjusted Trial Balance
Financial Accounting Basics: Part 5 – Posting Adjusting Entries
Financial Accounting Basics: Part 6 – Adjusted Trial Balance
Financial Accounting Basics: Part 7 – Creating Financial Statements
Financial Accounting Basics: Part 8 – Post Closing Entries
This article discusses taking the information from your adjusted trial balance in Part 6, and building your Balance Sheet, Income Statement and Cash Flow Statements.
In Part 6 we created a complete adjusted trial balance statement. Now we can create your “Financial Statements,” accounting reports that summarize your business’s activities over a set period of time. These are external reports designed to give your investors, lenders and creditors an understanding of your business’s financial health. They are also used internally as reports for owners to help guide financial decisions or assessments. The three main financial statements are, The Balance Sheet, The Income Statement and The Cash Flow Statement. We can build all of these using your adjusted trial balance.
Using the numbers from this Trial Balance we can match your current assets against your liabilities and equity, (remember the Core Principle, “Assets=Liabilities + Equity”) to now create your Balance Sheet for the end of the year:
It gives us a snapshot of your business’s assets, liabilities and equity at a single point in time. This can teach readers about your financial position; they can see what you own and what you owe at the end of your financial year.
You may notice that your Retained Earnings do not match the number from your adjusted balance sheet. That is because in Step 8 when we close out all the accounts, we fold the Net Income into Retained Earnings. The Income Statement will follow here in this example, we achieved a profit of $13,900 so our retained earnings for the year are: $65,100 (From the Balance Sheet) + $13,900 (From the Income Statement) = $79,000. This is why the Financial Statements are all done at the same time as they each reflect values from the others.
Now, let’s look at your Income Statement
This summarizes your business’s revenues and expenses over a period of time and gives the reader a glimpse of your financial performance and profitability by totalling your Net Income or Net Loss. If you were cash accounting this income statement would mirror your cash flows, but you are using the accrual method, so profit and cash flow are not the same thing. You keep track of your cash flow separately in a cash flow statement.
The Net Profit comes from the income statement and other numbers were created for this example.
This report summarizes your cash inflows and outflows over the same period of time. Once you have created these three financial statements you can send them out to your investors, lenders and creditors for further financing or loans. If BIG News was listed on a stock exchange, then investors would compare your performance against their expectations and decide whether to buy or sell shares in your business.
But there is still one more job to do and that is closing your accounts for the year so you can have a fresh new accounting year ahead. This is called Posting your Closing Entries and it will be discussed in Part 8, the final part in this series.
Download this resource article Financial Accounting Basics: Part 7 – Creating Financial Statements (pdf).