Financial Statements (Copy)

3.1.1 Financial Statements – Cheat Sheet

Purpose of Financial Statements

• Purpose: To provide relevant financial information for decision-making by stakeholders.
• Users:
  • Internal: Management, employees
  • External: Investors, creditors, suppliers, government

Key Financial Statements

1. Statement of Profit or Loss (Income Statement)
   • Purpose: Measures the profitability of the business over a specific period.
   • Components:
     • Revenue: Total income from sales or services.
     • Cost of Goods Sold (COGS): Direct costs related to production.
     • Gross Profit: Revenue – COGS.
     • Operating Expenses: Costs such as selling, general, and administrative.
     • Operating Profit: Gross profit – Operating expenses.
     • Other Income and Expenses: Non-operating items (e.g., interest, taxes).
     • Net Profit: Operating profit adjusted for other income/expenses.
2. Statement of Financial Position (Balance Sheet)
   • Purpose: Shows the business’s financial position at a specific date (assets, liabilities, and equity).
   • Components:
     • Assets:
       • Non-current Assets: Long-term assets (e.g., property, equipment).
       • Current Assets: Short-term assets (e.g., cash, receivables).
     • Liabilities:
       • Non-current Liabilities: Long-term debts.
       • Current Liabilities: Short-term debts (e.g., payables).
     • Equity: Owner’s investment in the business (calculated as: Equity = Assets – Liabilities).
3. Statement of Cash Flows
   • Purpose: Provides information about cash inflows and outflows over a period.
   • Components:
     • Operating Activities: Cash from core business operations.
     • Investing Activities: Cash flows from investments (e.g., buying/selling assets).
     • Financing Activities: Cash from issuing debt or equity, and paying off loans.
4. Statement of Changes in Equity
   • Purpose: Shows changes in the owner’s equity during the period.
   • Components:
     • Share capital: Amount raised from issuing shares.
     • Retained earnings: Profits kept in the business instead of being paid as dividends.
     • Other reserves: e.g., revaluation reserves.

Types of Businesses and Their Financial Statements

1. Sole Traders
   • Statements: Statement of Profit or Loss, Statement of Financial Position
2. Partnerships
   • Statements: Statement of Profit or Loss, Statement of Financial Position, Partnership Appropriation Account
   • Additional Info: Profit is allocated among partners based on the partnership agreement (interest on capital, salaries, profit-sharing ratio).
3. Limited Companies
   • Statements: Statement of Profit or Loss, Statement of Financial Position, Statement of Cash Flows, Statement of Changes in Equity
   • Additional Info: Includes share capital, retained earnings, and dividends.
4. Non-Profit Organizations (e.g., clubs, societies)
   • Statements: Statement of Receipts and Payments, Statement of Financial Position
   • Additional Info: Focus on funds received and paid rather than profit.
5. Manufacturing Businesses
   • Statements: Statement of Profit or Loss (with Manufacturing Account), Statement of Financial Position
   • Additional Info: Manufacturing Account details production costs (direct material, labor, overheads).

Accounting for Manufacturing Costs

1. Direct Materials: Raw materials directly used in production.
2. Direct Labor: Wages for workers directly involved in production.
3. Manufacturing Overheads: Indirect costs (e.g., factory rent, utilities).

Summary of Financial Statement Components

1. Statement of Profit or Loss
   • Revenue
   • Cost of Sales (COGS)
   • Gross Profit
   • Operating Expenses
   • Operating Profit
   • Other Income/Expenses
   • Net Profit
2. Statement of Financial Position (Balance Sheet)
   • Assets: Non-current (long-term) and current (short-term).
   • Liabilities: Non-current and current.
   • Equity: Owner’s share (Capital, Retained Earnings, Reserves).
3. Statement of Cash Flows
   • Operating Activities: Cash inflow/outflow from core business operations.
   • Investing Activities: Cash from purchase/sale of assets.
   • Financing Activities: Cash from financing, issuing debt/equity, repaying loans.
4. Statement of Changes in Equity
   • Share Capital: Raised from issuing shares.
   • Retained Earnings: Profits retained in the business.
   • Other Reserves: Special reserves like revaluation.

Conclusion

• Financial statements provide vital information for business decisions.
• Different types of businesses prepare financial statements according to their structure and needs.
• Manufacturing businesses have the additional step of preparing a Manufacturing Account to account for the production costs.