FINANCIAL STATEMENT

LESSON 1

FINANCIAL STATEMENTS: DEFINITION

Have you heard of the word financial statement? So what are financial statements?
From the word itself you can already define financial statement.

The first word is financial. It is related to finance; the financial situation of an

organization. Basically, it refers to all transactions of activities related to money.
For us to go deeper to the meaning of financial, let us identify first what are the
different financial activities or transactions of a business?

Anyone who can give an example of a financial activity of a business?

IN – OUT – ONHAND MONEY

With those activities, financial statement gives us information about the:
Business revenues, gains, expenses, losses
Assets and liabilities

How about the second word statement? What do you mean when you say
statement?

Financial statements are reports or a written record prepared by a company’s

management to identify their financial performance and position at a point in time.
It doesn’t mean that if you sold more than your target, your business is growing or
earning.

So why are they important?

It is very important as it gives accurate information about the business performance
and financial position of the company.
It helps all stakeholders including management, investors, to evaluate and make
decisions - comparing past and current performance and therefore predict future
performance and growth of the company.

Financial statements are the product of financial accounting. - Financial accounting

is the process of recording, summarizing and reporting a company's business
transactions.
They show the results of operation, financial condition, changes in owner's equity, -
represents the amount of money that would be returned to a company’s

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shareholders if all of the assets were liquidated and all of the company's debt was
paid off in the case of liquidation ( Assets – Liabilities) and sources and uses of cash.
The basic financial statements are:
1.income statement or statement of comprehensive income;
2. balance sheet or the statement of financial position or statement of financial
condition;
3. statement of changes in owner's equity (for a sole proprietorship) or statement
of changes in partners' equity (for a partnership) or the statement of changes in
stockholders' equity (for a corporation); and
4. cash flow statement or statement of cash flows.

LESSON 2 INCOME STATEMENT

Income statement, is one of the major financial statements now called

statement of comprehensive income and is also known as a profit and loss
statement, details the revenues earned and the expenses incurred by a company. It
shows the results of operation of a company, whether a company made profit or
incurred a loss. Basically, it gives us information if a company made or lost money in
a given time period. The "bottom line" in business parlance is the net profit or the
net loss of the business. If a company is "in the red, it means that the company is
incurring a net loss. – A net loss is when expenses exceed the income or total
revenue produced for a given period of time.
It shows the profitability of the firm. It covers a certain accounting period, a
month, a quarter, a six-month period, or a year. Yearly audited financial statements
are submitted to the SEC. – to protect the investors. It is intended to help investors
to see the company through the eyes of management. Also, to provide context for
the financial statements and information about the company's earnings and cash
flows.

For a service enterprise, the income statement is very simple. It is the most basic
income statement of all the types of companies. Since service-based companies do
not sell a product, the income statement will not contain cost of goods sold.
Therefore, the income statement will be a basic breakdown of income and expenses.
It simply lists the income from operations, like service revenue or professional fees,
and deducts from such revenue the total operating expenses.

Certainly, if the income is greater than the operating expenses, it will result in
operating profit.
On the other hand, if the income is less than the operating expenses, the result
is an operating loss.

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 To the operating profit or loss is added the net of the other income (interest
income, rent income, commission income, among others) less the other expenses
(interest expense, finance charges, among others). A sample income statement of a
service firm is shown below:

o REVENUE - fees or income generated from the sale of service.

 OPERATING EXPENSES are the costs a company incurs for running its day-to-
day operations.
o Rent and utilities
o Wages and salaries
o Accounting and legal fees
o Overhead costs such as selling, general, and administrative expenses
(SG&A)
o Property taxes
o Business travel
o OTHER INCOME - Also called as gains, indicate the net money made from
other activities, like the sale of long-term assets. These include the net
income realized from one-time non-business activities, like a company selling
its old transportation van, unused land, or a subsidiary company.
o OTHER EXPENSES - are expenses that do not relate to a company's main
business. Like interest to be payed in borrowings, buying new technology,
research and development (R&D)

EVERCLEAN LAUNDRY
Income Statement
For the year ended December 31, 2020

Laundry Revenue: 232, 400

Operating Expenses: 12,350
Cleaning Supplies Expenses 18,240
Utilities Expense 22,160
Rent Expense 48,000
Salaries Expense 40,500
Office Supplies Expense 10,220
Delivery Expense 15,230
Miscellaneous Expense 8,280
Operating Profit 174,980
57,420
Other Income
Interest Income 5,000
Other Expenses
Interest Expense (8,000) (3,000)
NET PROFIT 54,240

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The financial statements among service companies, trade are generally similar. The
difference is the detail calculation and the accounts used.

It is also little complicated. It shows the sales figure and deductions from gross sales
like sales discount and sales returns and allowance to arrive at net sales. From net
sales, the cost of sales is deducted which is computed by adding the beginning
inventory to the net cost of purchases and deducting the ending inventory. The cost
of sales is deducted from the net sales to arrive at the gross profit. From the gross
profit, the operating expenses are deducted to obtain the profit from operations or
operating profit. From the operating profit is added the net of other incomes and
other expenses to arrive at the "bottom line" or profit (or loss, if expenses are
greater than revenue).

o REVENUE - fees or income generated from the sale of service.

o SALES RETURNS AND ALLOWANCES - Sales returns occur when customers
return defective, damaged, or otherwise undesirable products to the seller.
o COST OF SALES - is the accumulated total of all costs used to create a product
or service, which has been sold.
The cost of sales is calculated as beginning inventory + purchases - ending
inventory.
o Beginning inventory – it is the value of all inventory held by a
business at the start of an accounting period, and represents all the
goods a business can put toward generating revenue.
o Net cost of purchases - the total amount of purchases made less any
discounts received, goods returned, and allowances made. Formula:
Net Purchases= Purchases – Returns – Allowances – Discounts
 Purchases - refer to the goods bought with the purpose of
selling.
 Purchase returns – the return of the goods the business makes
to the seller. This usually happens when the goods have failed
to meet a certain standard of the business or are obsolete or
damaged. Purchases are also returned when there is an excess
or surplus.
 Purchase allowances - the deductions in the total amount
made when the supplier gives goods at a lesser price due to
some defect or fault in the goods.

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 o Ending Inventory - is the value of goods still available for sale and held
by a company at the end of an accounting period.

The income statement of a trading corporation is shown below:

MATATAG MERCHANDISING
Income Statement
For the year ended June 30, 2020
Sales 120,000

Less: Sales Returns and Allowances 3,000

Net Sales 117,000
Less: Cost of Sales
Beginning Inventory 5,000
Add: Net Cost of Purchases
Purchases 80,000
Freight- In 1,000
Total Purchases 81,000
Purchase Returns and Allowances (2,000) 79,000
Total Goods Available for Sale 84,000
Less Ending Inventory 25,000 59,000
Gross Profit 58,000
Less: Operating Expenses
Communication Expense 1,000
Delivery Expense 5,000
Rent Expense 5,500
Salary Expense 8,300
Bad Debts Expense 600
Office Supplies Expense 700
Store Supplies Expense 1,500
Depreciation Expense
Furniture and Equipment 1,000 23,600
Operating Profit 34,400
Add: Other Income
Interest Income 800
Commission Income 1,500 2,300
Less: Other Expenses
Interest Expense 1,200 1,100
NET PROFIT 35,500

Product Costs vs Period Costs

Product costs are the costs of direct materials, direct labor, and overhead, also
called manufacturing cost. Direct materials and direct labor are variable costs or
costs that change in volume. This means that the more products are produced
(volume), the greater or higher the costs of direct materials and direct labor is,

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because they are directly incorporated into the product. Direct materials are
materials directly incorporated into the product like lumber for furniture, leather for
shoes and bags, and cloth for clothing (dress, pants, shirt, among others). Direct
labor covers the wages paid to all direct workers, 1.e., the workers doing the actual
production of the products manufactured by the company. These workers handle
jobs such as sewing for clothing manufacturers, carpentry for furniture
manufacturers, cutting and sewing for bags and shoes, among others. Overhead
(manufacturing/factory overhead) covers all manufacturing costs other than direct
materials and direct labor. This includes indirect materials (screws and bolts) and
manufacturing supplies (gasoline, oil, among others), salaries of factory or plant
managers and supervisors, salaries of factory staff, rent for the plant or factory site,
among others. Overhead could be fixed or variable. Variable means a change in
volume, while fixed means remains constant irrespective of volume. Indirect
materials and manufacturing supplies are variable; whereas, the salaries of the plant
managers and supervisors and office staff, the rent, the depreciation of the plant,
equipment, and machineries are all fixed. They do not change with volume, i.e., they
remain the same irrespective of the volume of production.

Product Costs
Product costs are the direct costs involved in producing a product. A
manufacturer, for example, would have product costs that include:

Direct labor
Raw materials
Manufacturing supplies
Overhead that is directly tied to the production facility such as electricity
For a retailer, the product costs would include the supplies purchased from a
supplier and any other costs involved in bringing their goods to market. In short, any
costs incurred in the process of acquiring or manufacturing a product are considered
product costs.

Product costs are often treated as inventory and are referred to as inventoriable
costs because these costs are used to value the inventory. When products are sold,
the product costs become part of costs of goods sold as shown in the income
statement.

Period Costs
Period costs are all costs not included in product costs. Period costs are not
directly tied to the production process. Overhead or sales, general, and
administrative (SG&A) costs are considered period costs. SG&A includes costs of the
corporate office, selling, marketing, and the overall administration of company
business.

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 Period costs are not assigned to one particular product or the cost of inventory
like product costs. Therefore, period costs are listed as an expense in the accounting
period in which they occurred.

Other examples of period costs include marketing expenses, rent (not directly
tied to a production facility), office depreciation, and indirect labor. Also, interest
expense on a company's debt would be classified as a period cost.

LESSON 3 BALANCE SHEET

The balance sheet is one of the three fundamental financial statements. It is also
called the statement of financial condition, sometimes called statement of financial
position shows the assets, liabilities, and owner’s equity of a business. It is based on
the fundamental equation: Assets = Liabilities + Equity. It shows the financial
condition or financial position of the business by showing what the business owns
and what it owes as well as the amount invested by its owners to fully credit their
operations. It details the company ‘s resources (assets) and obligations (liabilities)
and the composition of owner’s equity.

Balance sheet shows the liquidity and solvency of the firm. Liquidity refers to a
firm’s ability to meet its maturing obligation in the short run. It is their ability to pay
short-term bills/and payment and debts. It is also their ability to sell assets quickly to
raise cash. Solvency on the other hand, refers to the firm’s ability to meet maturing
obligations in the long run. Meaning, the company's ability to meet long-term debts
and continue operating into the future.

Let us go through the meaning of the different parts of the balance sheet.

ASSETS – what the business owns that can be converted to cash.

There are two main categories of assets included in the balance sheet; current
assets (, which can be converted to cash in one year or less) and non-current assets
or long-term or also referred as Property, Plant & Equipment assets which cannot.

1. Current Assets: Current assets can easily be converted to cash within a year
or less. Current assets are further broken down on the balance sheet into
these accounts:
 Cash and cash equivalents: These are your most liquid assets, including
currency, checks and money stored in your business’s checking and savings
accounts
 Marketable securities: Investments that you can sell within a year
 Accounts receivable: Money that your clients owe you for your services that
will be paid in the short term

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  Inventory: For businesses that sell goods, inventory includes finished
products and raw materials
 Prepaid expenses: Things of value that you’ve already paid for, like your office
rent or your business insurance.

2. Non-current assets : It refer to the resources of the firm that are durable or
will last longer than a year like land, building, equipment, furniture, fixture
and long-term investments. Long-term assets won’t be converted to cash
within a year. They can be further broken down into:
 Fixed assets: Includes property, buildings, machinery and equipment like
computers
 Long-term securities: Investments that can’t be sold within one year
 Intangible assets: Assets that aren’t physical objects, such as copyrights,
franchise agreements and patents

LIABILITIES

The next section of a balance sheet lists a company’s liabilities. The liabilities are the
money that the business owe to others, including the recurring expenses, loan
repayments and other forms of debt. Liabilities are further broken down into current
and long-term liabilities.

1. Current Liabilities: Current liabilities, also known as short-term liabilities, are

debts or obligations that need to be paid within a year.
Examples of current liabilities:
 Accounts payable
 Interest payable
 Income taxes payable
 Bills payable
 Bank account overdrafts
 Accrued expenses
 Short-term loans
2. Long – term Liabilities: Long-term liabilities are any debts and payables due
at a future date that's at least 12 months out. Examples are mortgage loan,
bonds payable.

For example, if a company takes out a five-year, $4,000 loan from a bank, its assets
(specifically, the cash account) will increase by $4,000. Its liabilities (specifically, the
long-term debt account) will also increase by $4,000, balancing the two sides of the
equation. If the company takes $8,000 from investors, its assets will increase by that
amount, as will its shareholders' equity. All revenues the company generates in
excess of its expenses will go into the shareholders' equity account. These revenues

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will be balanced on the assets side, appearing as cash, investments, inventory, or
some other asset.

SHAREHOLDERS EQUITY

Shareholders equity refers to the amount of money generated by a business, the

amount of money put into the business by its owners (or shareholders) and any
donated capital.

Examples:

 Retained earnings are the net earnings a company either reinvests in

the business or use to pay off debt; instead of paying it out as a
dividend to stockholders. The rest is distributed to shareholders in the
form of dividends.

Common stock - It represents the total amount of stock the company has issued to
public investors, company officers, and company insiders.

Stakeholders Equity = Total Assets – Total Liabilities

Total assets are divided into current assets and non-current assets ( at times
identified as property, plant, and equipment of fixed assets). Current assets are the
resources that will be used for current operations (short term) or within the current
operating cycle. Non-current assets refer to the resources of the firm that are
durable or will last longer than a year like land, building, equipment, furniture,
fixture and long-term investments.

See example of a manufacturing company’s balance sheet below:

RA Manufacturing Company
Balance Sheet
December 31, 2020
ASSETS
Current Assets
Cash 464,000
Marketable Securities 164,00
Accounts Receivable 550,000
Allowance for Bad Debts (17,800)
Inventories 532,200
Finished Goods 346,000
Work in Process 200,360
Raw Materials 80,500
Mfg. Supplies 19,500 646,360
Prepaid Expenses (business making advanced 44,000

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 payments for goods or services to be received in the future.)
Total Current Assets 1,850,560
Property, Plant and Equipment
Land 129,800
Buildings 609,220
Acc. Dep (123,600) 485,620
Machinery and Equipment 2,5050,800
Acc. Dep (1,500,000 1,005,800 1,621,220
)
TOTAL ASSETS 3,471,780

LIMITED AND STOCKHOLDERS EQUITY

Current Liabilities
Accounts Payable 198,960
Accrued Payroll, Taxes and Interest 227,190
Estimated Income Taxes 19,950
Current Portion of Long-term Debt 39,200
Total Current Liabilities 485,300
Long term Debt 535,500
TOTAL LIABILITIES 1,020800

Stockholder’s Equity 800,000

Common Stock 51,600
Premium on Common Stock 1,599,380
Retained Earnings 2,450,980

TOTAL LIABILITIES AND STOCKHOLDER’S 3,471,780

EQUITY

Total liabilities are divided into current liabilities and non-current liabilities or
long-term liabilities. Current liabilities are obligations of the firm that will mature or
need payment during the current accounting period or accounting year. Noncurrent
liabilities are the obligations of the firm that will mature or become due within more
than a year. That portion of the long-term liability that is due during the current
period is classified as a current liability and the rest of balance is classified as long
term or non-current.

Owner’s equity (for sole proprietorship), partner’s equity (for a partnership), or

stockholder’s equity (for a corporation) should equal total assets minus total
liabilities. Such equity is composed of the initial or original investment plus additional
investments, and the profit is added or loss deducted from the total investments.
The total of the liabilities and the owner’s equity should equal to total assets.

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 LESSON 4 CASH FLOW STATEMENT

The cash flow statement is sometimes called the funds flow statement or the
statement of the sources and uses of cash or the statement of sources and uses of
funds. Cash and funds are used interchangeably. According to Bernstein (1993),
feedback received by the Financial Accounting Standards Board (FASB) on the
conceptual framework project indicated an overall consensus among users of
financial statements that a cash flow statement would be more than useful than any
other funds flow statement. It can be a simple statement of cash receipts and cash
disbursements as is done in very small businesses.

The cash flow statement (CFS) shows how much cash is entering and leaving the
business on a specific period of time or known as accounting period. So, the business
would know how effective a business is managing its cash and what they spend.

As we all know, cash is the lifeblood of any business. If they cant pay their
employees, the supplier or your taxes, its already game over.

We previously learned the difference between cash and revenue. Earning

revenue doesn’t always mean increase in cash immediately and incurring expenses
doesn’t always mean decrease in cash always. What financial statement would an
account refer if he/she wanted to know the cash? – The BALANCE SHEET. If they
want to find out the cash, they can look at the balance sheet. They can identify if the
cash they have has increased or increased. But it is not clear how the cash went into
the business and how it is spent on. So to get the complete picture of the business,
we need to compute the cash flow statement.

The cash flow statement complements the balance sheet and income statement
and is a mandatory part of a company's financial reports.

The income statement actually consists of 3 main parts, 1 st is cash flow from
operations, which generates how much cash is generated with the actual operations
of the business.

Next is cash flow from investing activities, as the name says, it is cash spent on
investments or cash received from sales of investments. We can see if the company
has purchased investments like machinery and equipment, or acquired another
business.

Last one is cash flow from financing activities. This summarizes cash transactions
that involves raising, borrowing and repaying capital. Like a bank loan was take out
or debt was repaid.

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 So the computation must be beginning cash plus cash flow from operations
minus the cf from financing minus cf from investing equals ending cash.

Below is an example of a very simple cash flow statement for a sole proprietorship,
showing cash receipts and disbursements without the need of the comparative
balance sheets (balance sheets for two consecutive accounting periods).

Masikap Enterprises
Cashflow Statement
For the year ended December 31,2020
Cash Receipts:
Additional Investment by Owner 100,000
Loan from Bank 200,000
Collection from Customers 122,500 422,500
Cash Disbursements
Payment to Suppliers 150,000
Partial Payment of Bank Loan 20,000
Operating Expenses 200,00 (370,000)
Net Cash Inflow 52,500

Accounting principles and standards dictate the use of the accrual method of
accounting, where recognition of income and expenses are made when income is
earned, regardless when cash is received, and expenses are recognized when
expenses are incurred, irrespective of when they are paid. The profit or net income
shown in the income statement does not show the cash position of the company.
Income in the income statement can only be "paper profits" if receivables are not
collected and converted into cash. This is the basic reason why the cash flow
statement is important to provide additional information as to the cash position,
which is an indication of the liquidity of the firm. The cash flow statement is a valid
analytical tool to help financial analysts analyze and assess a company's short-term
liquidity and operating performance.

Balance sheet example:

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