Understanding Financial Statements

The financial statements shown on the next several pages are for a sole proprietorship, which is a business owned by an individual. Corporate financial statements are slightly different. The four basic financial statements are the income statement, statement of owner's equity, balance sheet, and statement of cash flows. The income statement, statement of owner's equity, and statement of cash flows report activity for a specific period of time, usually a month, quarter, or year. The balance sheet reports balances of certain elements at a specific time. All four statements have a three‐line heading in the following format:


Income statement. The income statement, which is sometimes called the statement of earnings or statement of operations, is prepared first. It lists revenues and expenses and calculates the company's net income or net loss for a period of time. Net income means total revenues are greater than total expenses. Net loss means total expenses are greater than total revenues. The specific items that appear in financial statements are explained later.

The Greener Landscape Group Income Statement For the Month Ended April 30, 20X2

Revenues

    Lawn Cutting Revenue

$845

Expenses

    Wages Expense

$280

    Depreciation Expense

235

    Insurance Expense

100

    Interest Expense

79

    Advertising Expense

35

    Gas Expense

30

    Supplies Expense

25

      Total Expenses

784

Net Income

$ 61

Statement of owner's equity. The statement of owner's equity is prepared after the income statement. It shows the beginning and ending owner's equity balances and the items affecting owner's equity during the period. These items include investments, the net income or loss from the income statement, and withdrawals. Because the specific revenue and expense categories that determine net income or loss appear on the income statement, the statement of owner's equity shows only the total net income or loss. Balances enclosed by parentheses are subtracted from unenclosed balances.

The Greener Landscape Group Statement of Owner's Equity For the Month Ended April 30, 20X2

J. Green, Capital, April 1

$ 0

Additions

    Investments

$15,000

    Net Income

61

15,061

Withdrawals

(50)

J. Green, Capital, April 30

$ 15,011

Balance sheet. The balance sheet shows the balance, at a particular time, of each asset, each liability, and owner's equity. It proves that the accounting equation (Assets = Liabilities + Owner's Equity) is in balance. The ending balance on the statement of owner's equity is used to report owner's equity on the balance sheet.

The Greener Landscape Group Balance Sheet April 30, 20X2

ASSETS

Current Assets

    Cash

$ 6,355

    Accounts Receivable

200

    Supplies

25

    Prepaid Insurance

1,100

      Total Current Assets

7,680

Property, Plant, and Equipment

    Equipment

$18,000

    Less: Accumulated Depreciation

(235)

17,765

      Total Assets

$25,445

LIABILITIES AND OWNER'S EQUITY

Current Liabilities

    Accounts Payable

$ 50

    Wages Payable

80

    Interest Payable

79

    Unearned Revenue

225

      Total Current Liabilities

434

Long-Term Liabilities

    Notes Payable

10,000

      Total Liabilities

10,434

Owner's Equity

    J. Green, Capital

15,011

      Total Liabilities and Owner's Equity

$25,445

Statement of cash flows. The statement of cash flows tracks the movement of cash during a specific accounting period. It assigns all cash exchanges to one of three categories—operating, investing, or financing—to calculate the net change in cash and then reconciles the accounting period's beginning and ending cash balances. As its name implies, the statement of cash flows includes items that affect cash. Although not part of the statement's main body, significant non‐cash items must also be disclosed.

According to current accounting standards, operating cash flows may be disclosed using either the direct or the indirect method. The direct method simply lists the net cash flow by type of cash receipt and payment category. For purposes of illustration, the direct method appears below.

The Greener Landscape Group Statement of Cash Flows For the Month Ended April 30, 20X2

Cash Flows from Operating Activities

    Cash from Customers

$ 870

    Cash to Employees

(200)

    Cash to Suppliers

(1,265)

      Cash Flow Used by Operating Activities

(595)

Cash Flows from Investing Activities

    Purchases of Equipment

(8,000)

Cash Flows from Financing Activities

    Investment by Owner

15,000

    Withdrawal by Owner

(50)

      Cash Flow Provided by Financing Activities

14,950

Net Increase in Cash

6,355

Beginning Cash, April 1

0

Ending Cash, April 30

$6,355