The purpose of financial statements is to provide useful and relevant accounting information in a way that may be understood and which allows users to reliably determine the financial performance and position of the company. In this introductory course I will briefly explain three financial statements found in a company’s annual report- The balance Sheet, The Income Statement, and the Statement of movements in Equity
Balance Sheet: The purpose of the balance sheet is to identify the financial position of the firm at one point in time. Simply speaking it lists the assets, liabilities and equity of a company. Equity is defined as the difference between Assets and Liabilities:
Equity = Asset – Liability
Example: Prepare a balance sheet given the following information:
- $5,000 in the bank
- A house valued at $500,000
- A mortgage valued at $400,000
- A car worth $20,000
- $10,000 owed to your parents
Answer:
Income Statement: Summarises how much money the company has earned in a period. In accounting it is defined as change in net wealth.
Below is an example of an income statement for a retail store:
- An important note is the difference between “cost of goods sold” and “other expenses”. Broadly speaking cost of goods sold are expenses directly related to the sale of the assets. For a manufacturing company this might be the cost of raw materials and cost of employing people to make the product. By contrast other expenses are general expenses such as rent and insurance.
- You may have also noticed the brackets in a number of figures. The brackets represent a negative figure or in this case an expense
Statement of Movements in Equity: As the name suggests this statement represents the changes in the value of equity during a period. Common examples of events that will affect this statement include:
- Profit: After paying debt holders (i.e. after paying interest). The residual funds is given to equity holders
- Dividends: When a company gives a dividend it is distributing cash to the shareholders. Broadly speaking it is giving back to shareholders part of the profit that the company has earned. It therefore causes a reduction in Equity
- Issuing shares. When a company issues shares it is basically asking for money from shareholders. When this happens the Equity account increases as there are more shareholders
Example:
- A company has equity of $1,000,000
- It makes a Net profit after Tax of $100,000
- It pays a dividend of $80,000
- It issues $200,000 in shares
