Introduction to Financial Statements
Finance is one of the most crucial topics that one must know before starting a business. This blog covers the basics of a subtopic of finance; the financial statements.
Finance refers to the management of large amounts of money, especially by governments or large companies. Individuals also manage their own finances, but there is a huge difference between personal finance and the financing of a company. Starting a company requires tremendous knowledge of multiple topics such as marketing, stocks, economics, and much more.
There are three types of financial statements:
- Profit and Loss statement(P&L)
- Balance sheet
- Cash flow statement
To practically understand these statements, assume that a small lemonade stand company, called Josh’s Lemonade is set up. What would its financial statements look like?
Profit and Loss statement
The income statement includes the revenue or turnover, the expenses and the net profits. So, suppose Josh sets up one lemon stand down the street, and after a year of starting his business, writes down his P&L statement:
|Cups sold per stand:||800|
|Price per cup:||$1.00|
|Less: COGS||200(Cost of inventory)|
|Less: Depreciation||60(Assumes 5-year useful life for the stand)|
|Less: Labor expense||$530|
|Less: Interest||25(10% of 250)|
|Less: Taxes||5(35% of EBIT)|
COGS: Costs of Goods sold refers to the selling price of the product; basically, the money needed to serve customers
EBIT (Earnings before Interest and Taxes): It is basically the revenue generated from a business, including the cost of goods sold.
Per share: There are multiple shares of each public company. Individuals or other companies may own these shares and expect them to grow in value. These shares may be bought by others, who see the potential of the company and those who bid on the shares’ value to plummet, sell them.
One book that I would recommend to anyone who wants to learn more about Financial Statements is:
The Balance Sheet
A balance sheet shows the assets, the liabilities and the net worth or shareholders’ equity of the company in a tabular form. These three categories constitute what is known as the accounting equation:
Assets= Liabilities + Equity
The balance sheet of Josh’s lemonade stand is as follows:
Current Assets: An item of property owned by a person or company, regarded as having value and available to meet debts, commitments, or legacies. Assets can be in the form of liquid cash, deposit accounts, money orders or short-term investments.
Fixed Assets: Assets that are purchased for long-term use and are not likely to be converted quickly into cash. Fixed assets include Property plants, equipment/tools, machinery and furniture. These assets wear out over time, and sometimes even require maintenance.
Liabilities: Things for which someone is responsible, especially the amount of money owed. Liabilities are in the form of debt, such as rental payment or loans.
Goodwill: The established reputation of a business regarded as a quantifiable asset and calculated as part of its value when it is sold.
Cash flow statement
Cash flow statement
|Cash Flow from operations:|
|Cash Flow from Investing:|
|Capex (Capital expenditure):||300|
|Cash Flow from Financing:|
|Change in cash||500|
CFO: Cash flow from operating activities indicates the amount of money a company makes from ongoing activities such as manufacturing or selling of goods and services.
CFF: ‘Cash flow from’ shows the net flow of cash that are used to fund a company.