Businesses create financial statements, or reports, to simplify information contained in the General Ledger they use to make business decisions.
Terms and Concepts:
It is important that information transfers from one document to another accurately.
Recording dates on Financial Statements:
Income Statements compare REVENUE and EXPENSES in the same reporting period (Matching Expenses with Revenue).
There are four sections:
- Heading (Company Name, Income Statement, For Month Ended Month Day Year)
- Net income or loss
Balance Sheets report financial information on a specific date; show the current financial condition, or strength. Include ASSETS, LIABILITIES, AND OWNER'S EQUITY, all of the permanent accounts in the general ledger.
There are four sections:
- Heading (Company Name, Balance Sheet, Month Day Year)
- Owner's Equity
Statement of Cash Flows
This report shows changes in cash during the accounting cycle; the amount of cash that came in and the amount of cash that was paid out.
Calculating Current Capital:
Current Capital is the adjusted amount that goes on the Balance Sheet. The amount is adjusted to reflect changes in Owner's Equity during an accounting cycle.
When there is a Net Income:
Capital Account Balance + Net Income - Drawing Account Balance = Current Capital
When there is a Net Loss:
Capital Account Balance - Net Loss - Drawing Account Balance = Current Capital
Ratio Analysis is used to measure a business's financial performance during an accounting cycle; the information is often used to make management decisions and also to attract investors.
Profitablility ratios evaluate the earnings performance of a business during an accouonting period. From Investopedia:
A class of financial metrics that are used to assess a business's ability to generate earnings as compared to its expenses and other relevant costs incurred during a specific period of time. For most of these ratios, having a higher value relative to a competitor's ratio or the same ratio from a previous period is indicative that the company is doing well.
Return on Sales measures the portion of each sales dolllar that represents profit for the business.
Net income ÷ Total Revenue (Sales)
Liquidity Measures show how easily an asset can be converted to cash. Cash is 100% liquid; buildings and equipment are a lot less liquid because it will take some time and effort to convert them to cash.
Liquity ratios measure a business's ability to pay its current debts.
Current Ratio compares assets and liabilities to determine a business's ability to pay its current debts. Investors looks for a current ratio of 2:1 (current assets is at least twice current liabilities) or higher.
Current Assets ÷ Current Liabilities = Current Ratio where Current Assets includes cash, receivables, and supplies.
Quick ratio measures a business's liquidity. 1:1 is considered adequate for most businesses.
Cash and Receivables ÷ Current Liabilities = Quick Ratio