Financial Statements LESSON 15. What are Financial Statements?

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1 Financial Statements LESSON 15 Main Idea Business owners must have accurate and timely information about the fi nancial status of their business to make the best decisions. Most of this fi nancial information is derived from fi nancial statements. Wellprepared fi nancial statements can provide a guide for getting the business started and for keeping it on a successful path. What are Financial Statements? Financial statements are reports that give a detailed picture of a business s fi nancial status for a given period of time. Financial statements detail changes in a business s fi nancial status. Study of fi nancial statements can tell a business owner whether the business is on a successful path or if there are fi nancial troubles ahead. Two of the most common fi nancial statements are the income statement and the balance sheet. The Income Statement An income statement is a report that outlines projected business revenue and projected business expenses for a given period of time. Revenue is the money collected for products sold by a business. The difference between revenue and expenses is the business s profi t. This statement, also known as the P and L (profi t and loss), is the most frequently used fi nancial statement. It is your main scorecard for projecting profi t or loss for a specifi ed period of time a month, three months, or a year. When business owners refer to the bottom line, they re talking about the bottom line of the income statement: profi t. Profi t is the money made by a business once costs and expenses have been deducted from the revenue. The information contained in an income statement will tell a business owner how well his or her business is doing. There are many components of an income statement: After completing this lesson you will be able to: Defi ne the components of an income statement Identify the line items that make up a balance sheet Explain how fi nancial statements can be used to evaluate past business and predict future performance Calculate equity based on assets and liabilities Compute revenue, net sales, gross margin, and net profi t Identify different businesses based on fi nancial statements Key Terms Financial Statements Income Statement Revenue Profi t Gross Sales Net Sales Cost of Goods Sold Gross Margin Operating Expenses Taxes Net Income Net Profi t or Loss Balance Sheet Equity Lesson 15 Financial Statements 129

2 Gross sales: this fi gure for a new business will be an estimate of sales for the time period. For an established business, this is the amount of money made from selling store merchandise. Net sales: the amount of money in sales after returns and discounts are subtracted. Cost of goods sold: the amount of money spent to buy the merchandise that is sold. Gross margin: the amount of money that remains from net sales less the cost of goods sold. This is the amount of money that will be used to pay the business s expenses for the period and then deliver the business s profi t or loss. Operating expenses: all of the expenses associated with running the business. Income: the amount of money left after subtracting the operating expenses from the gross margin. Taxes: the amount of money owed to federal, state, and local governments. The estimated amount of taxes is deducted from income. Net income: the amount of money left after taxes are deducted. Profi t means that the business gained money during the time period, while loss means that the business lost money during the time period. The Balance Sheet The balance sheet is a report that summarizes the business s assets and liabilities and the owner s equity. We discussed that assets are tangible items of value owned by a business, such as a store s inventory or cash. Liabilities are debts that a business has, such as loans, wages, or taxes owed. The difference between assets and liabilities is called equity. The purpose of a balance sheet is to show a clear picture of the business s assets and liabilities; it provides a snapshot of assets and liabilities for the point in time at which it is prepared. Analysis of Past Performance It is important to carefully analyze the information provided in fi nancial statements. Analysis will help to determine patterns or trends. The information can also reveal areas of potential concern before they become major problems. Analysis of past business performance can help with planning for a successful future. Predicting Future Performance Financial statements can be effective tools to help plan the future of a business. For instance, if your business records show a pattern of sales that increase signifi cantly during the summer months, you can then arrange to purchase additional inventory for those months. Doing so will ensure that there is enough merchandise on the sales fl oor for maximum revenue during that prime period. 130 Virtual Business Retailing 3.0

3 Financial statements often prepared based on projections or estimates of future events, such as sales or purchases, are referred to as pro forma fi nancial statements. Pro forma is a Latin term that means according to form. Pro forma fi nancial statements are used in business plans when the business being proposed has not yet been started. Business Plans and Financial Statements A business plan is a map or blueprint for starting a new business. As we will learn in the unit on business plans, fi nancial information is a major part of a business plan. A business plan requires fi nancial information that includes projected income and expenses, projected cash fl ow, and a projected balance sheet for the fi rst business year. Summary In this unit we have looked at the purpose and importance of fi nancial statements to both new and established businesses. We specifi cally examined the information contained in income statements and balance sheets. Additionally, we discussed the importance of analyzing the information provided by fi nancial statements and how that analysis can be useful. Lastly, we reviewed some of the mathematics used in producing fi nancial statements. Lesson 15 Financial Statements 131

4 Key Math Concepts COMPUTE REVENUE To compute revenue, use this formula: Revenue = Unit Sales x Average Price per Unit COMPUTE NET SALES Net sales are a part of the income section of an income statement. To compute net sales, use this formula: Net Sales = Total Sales Returns and Discounts COMPUTE GROSS MARGIN To compute gross margin from sales, use this formula: Gross Margin from Sales = Net Sales Cost of Goods Sold COMPUTE NET PROFIT To compute net profi t, use this formula: Net Profi t = Total Revenue Total Expenses COMPUTE EQUITY ON A BALANCE SHEET To compute equity on a balance sheet, use this formula: Equity = Assets Liabilities Key Terms Financial Statements Reports that give a detailed picture of a business s fi nancial status for a given period of time. Income Statement A report that outlines projected business revenue and projected business expenses for a given period of time. Revenue Money collected for products sold by a business. Profit The money made by a business once costs and expenses have been deducted from the revenue. Gross Sales The amount of money made from selling store merchandise. Net Sales The amount of money in sales after returns and discounts are subtracted. Cost of Goods Sold The amount of money spent to buy the merchandise that is sold. Gross Margin The amount of money that remains from net sales less the cost of goods sold. Operating Expenses All of the expenses associated with running the business. Taxes The amount of money owed to federal, state, and local governments. Net Income The amount of money left after taxes are deducted. Balance Sheet A report that summarizes the business s assets and liabilities and owner s equity. Equity The difference between the assets and liabilities of a business. 132 Virtual Business Retailing 3.0

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