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An entity's financial statements generally consist of:
Each of these statements will be considered in turn.
The profit and loss statement (or income statement) shows the
profit or loss for the period. It is usually headed "for the
year ended...". Up until 30 June 2005, the profit and loss
statement was also referred to as the statement of financial
performance. The profit and loss statement includes:
- Revenues, and
- Expenses of the business for the relevant period.
The difference between revenues and expenses is referred to as
the net profit / (loss). Some organisations, particularly
non-profit organisations, refer to this figure as the net
surplus/(deficit). Net profit / (loss) is defined as: Net profit / (loss) = Revenues - Expenses
Revenues are inflows derived by the entity as a result of the
sale of goods or provision of services. Revenues typically
include sales, interest received, rent received, dividends
received, etc. Another term for revenue is income.
Expenses are day-to-day outflows incurred by the business in
providing goods or services to customers. Expenses typically
include advertising, accounting fees, bank charges, cleaning,
electricity, insurance, interest paid, motor vehicle expenses,
postage, printing and stationery, rent, salaries and wages,
superannuation and telephone. The profit (or loss) in the profit and loss statement is
ultimately transferred to the equity section of the balance
sheet (under the account entitled "current year profit"). Over
the years, the accumulated profit is referred to as "retained
profits". Alternatively, if this account represents losses, it
is referred to as "accumulated losses".
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The balance sheet reports the entity's:
- Assets
- Liabilities
- Equity
Assets are defined as future economic benefits owned or
controlled by the entity. Assets are essentially anything owned
by the entity that is valuable and contributes to revenue
generation. Assets typically include cash at bank, accounts
receivable, inventory, land and buildings, and plant and
equipment. Assets are usually classified as either current or non-current
assets. If an asset is expected to be "realised" (or converted
into cash) within the next 12 months, it is classified as a
current asset. Conversely, if an asset is not expected to be
converted into cash within the next 12 months, it is classified
as a non-current asset in the balance sheet. Liabilities are defined as future
"sacrifices" of economic
benefits that the entity is presently obliged to make to other
entities. Essentially, liabilities are amounts owed by the
entity to external parties. Liabilities typically include bank
overdrafts, accounts payable, provision for annual leave and
long service leave, tax liabilities and loans payable. Once again, liabilities are classified as either current or
non-current. If a liability is expected to be settled (or paid)
within the next 12 months, it is classified as a current
liability. Conversely, any liability not expected to be settled
within the next 12 months is classified as a non-current
liability in the balance sheet. Equity is generally made up of:
- Capital;
- Retained profits (or accumulated losses); and
- Reserves.
Equity represents the investments (both initial and ongoing)
made by the owners of the entity and the sum of accumulated
profits made over the years. The higher the equity, the more the
business is worth. When a business makes a profit, equity
increases. Conversely, if a business makes a loss, this has the
effect of decreasing equity. Following is a summary of useful accounting formulae: Total assets = Current assets + Non-current assets Total Liabilities = Current Liabilities + Non-current
liabilities Net assets = Total assets - Total liabilities Net assets is also referred to as equity Equity = Assets
- Liabilities Net profit/(loss) = Revenues - Expenses
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A cash flow statement reports the cash position of the entity
during the reporting period. It is usually headed "for the year
ended...". Preparation of a cash flow statement has been required
in Australia since 30 June 1992. The cash flow statement reports the cash inflows and cash
outflows of the business during the financial year. The cash
flow statement reconciles the amount of cash on hand at the
beginning and end of the reporting period. Cash flows are broken down into three components:
- Cash flows from operating activities;
- Cash flows from financing activities; and
- Cash flows from investing activities.
The most important activity is cash flows from operating
activities. In essence, these are the cash inflows and cash
outflows from day-to-day activities (or cash profit). Whilst the profit and loss statement shows revenues and expenses
under accrual accounting principles, the cash flow statement is
prepared under cash accounting concepts (i.e. cash in and cash
out). For this reason, many people consider the cash flow
statement to be more useful than the profit and loss statement. Whilst cash flow statements are often included in external
financial statements, they are not usually prepared by
bookkeepers.
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