In my last blog, I highlighted what I call the Big Five in Accounting: Assets, Liabilities, Equity (or Shareholders’ Funds for incorporated companies), Income and Expenses. In this blog, I will highlight the key financial statements for all organisations, and show how they link up with the Big Five.
Financial statements are a formal record of the financial activities of an organisation or person. They are typically presented in a fairly standardised and user-friendly manner. For larger organisations, they will be accompanied by a detailed set of footnotes which describe each item in those statements.
Two key financial statements are as follows:
1. Income Statement: this summarises the organisation’s income, expenses and net profit over a given period (e.g. one year). This is often called Profit & Loss Statement (especially for companies). For councils, they used to be known as Statement of Financial Performance. This actually indicates what it is – a summary of how the organisation performed financially during a given accounting period. Councils now usually call them Income Statements, and call the bottom line Net Surplus (or Deficit) rather than Net Profit (or Loss).
A simplistic example for a company that sells products (hence Cost of Goods Sold) is as follows:
Income Statement for ABC Company for Year ended 30 June 2015
Less Cost of Goods Sold b $620,000
Gross Profit $580,000
Salaries and wages $295,000
Printing and stationery $8900
Interest paid $950
Total Expenses $399,750
Net profit before tax $180,250
Income tax $54,075
Net profit after tax $126,175
2. Balance Sheet: This summarises the assets, liabilities and equity (or shareholders’ funds) of an organisation as at a particular date (e.g. 30 June 2015). For councils, this used to be known as Statement of Financial Position. A simple example of a Balance Sheet is as follows:
Balance Sheet for ABC Company as at 30 June 2015
Short-term investments 45,000
Land and Buildings 125,000
Motor vehicles 51,250
Plant and machinery 43,100
Less accumulated depreciation (39,300)
TOTAL ASSETS 370,200
Bank overdraft 8750
Provision for leave 4500
Provision for bad debts 2800
Long-term Loan 40,000
Provision for long-service leave 17,500
TOTAL LIABILITIES 73,550
NET ASSETS 296,650
A few points about the items on the Balance Sheet:
- Current Assets are those assets that are either cash or are normally and readily converted to cash within a 12 month period. So while you could sell motor vehicles, land, buildings, etc. within short notice, this is not normally what we purchase them for, so they are usually shown as non-current assets.
- Accumulated Depreciation: this is the sum total of depreciation of an asset(s) that has accumulated over time. It is important to show non-current assets at their current value.
- Current Liabilities are those debts that need to be paid within a twelve month period.
- Provisions for long-service leave, etc.: are liabilities because they are debts that will ultimately need to be paid.
- Net Assets and Equity: are always the same, and are calculated by subtracting an organisation’s liabilities from its assets, as shown.
The Cash Flow Statement is the third key financial statement which I shall mention in passing. This is concerned with the flow of cash in and out of the business, and analyses this flow in terms of its operating, investing, and financing activities. As an analytical tool, it is useful in determining the short-term viability of a company, particularly its ability to pay bills. As you may know, an organisation can be asset-rich and cash-poor, lacking the ability to pay debts and forthcoming expenses.
The Current Ratio is one useful ratio, which demonstrates the ability of an organisation to meet its short-term debts. This expresses current assets as a proportion of current liabilities, and a benchmark figure for this is usually 2:1. In other words, there are twice as many available current assets as there are current liabilities.
Hopefully this has all made sense! There is only so much one can explain in a blog, of course. We should be mindful that the above financial statements don’t tell the full story, and there is much other information and many other ratios and statistics that will give a fuller picture of the financial health and longer-term viability of an organisation.
Narayan van de Graaff