Lecture’s Topic : Financial

Statements
1. What are Financial Statements?

Financial statements are formal records of the financial activities of a business. They are crucial
tools for understanding a company's financial performance and stability. Financial statements
help stakeholders, such as investors, management, and creditors, make important decisions about
the company.

Three primary financial statements are:

1. Income Statement: Shows a company’s revenue, expenses, and profit over a specific
period.
2. Balance Sheet: Summarizes the company’s assets, liabilities, and equity at a specific
date.
3. Cash Flow Statement: Tracks the flow of cash into and out of the business.

2. Income Statement (Profit & Loss Statement)

The income statement shows how much money a company earned and spent during a particular
period. It is used to measure the business’s profitability.

Key Components:

1. Revenue (Sales):
o This represents the total income generated from the sale of goods or services. It is
the starting point of the income statement.
o Example: If a company sells 100 units at $100 per unit, the revenue is $10,000.
2. Cost of Goods Sold (COGS):
o This is the direct cost attributable to producing the goods or services sold by the
company. It includes:
 Direct materials: Raw materials used to produce goods.
 Direct labor: Wages of employees who are directly involved in
production.
 Manufacturing overhead: Costs like electricity for production equipment
or factory maintenance.
 oFormula: COGS=Opening Inventory+Purchases−Closing Inventory\text{COGS}
= \text{Opening Inventory} + \text{Purchases} - \text{Closing
Inventory}COGS=Opening Inventory+Purchases−Closing Inventory
3. Gross Profit:
o This is the profit made after deducting COGS from revenue.
o Formula: Gross Profit=Revenue−COGS\text{Gross Profit} = \text{Revenue} -
\text{COGS}Gross Profit=Revenue−COGS
o It indicates the efficiency of production and pricing strategy.
4. Operating Expenses:
o These are indirect costs associated with running the business, including:
 Administrative expenses: Office supplies, management salaries.
 Selling expenses: Advertising, marketing, sales commissions.
 Depreciation: The reduction in the value of assets (e.g., equipment) over
time.
5. Operating Profit (EBIT):
o Also known as earnings before interest and taxes (EBIT), this is the result after
deducting operating expenses from gross profit.
6. Net Profit (Net Income):
o The final figure after all expenses, including taxes and interest, are deducted.
o Formula: Net Profit=Operating Profit−Interest−Taxes\text{Net Profit} =
\text{Operating Profit} - \text{Interest} -
\text{Taxes}Net Profit=Operating Profit−Interest−Taxes

Example Layout of Income Statement:

Income Statement Amount

Revenue $20,000
- Cost of Goods Sold (COGS) ($8,000)
Gross Profit $12,000
- Operating Expenses ($5,000)
Operating Profit (EBIT) $7,000
- Interest Expense ($1,000)
- Taxes ($1,500)
Net Profit $4,500

3. Balance Sheet

The balance sheet provides a snapshot of a company’s financial position at a specific point in
time. It shows what the company owns (assets), what it owes (liabilities), and the owner's equity,
which represents the owner’s residual claim on the assets.

Balance Sheet Equation: Assets=Liabilities+Equity\text{Assets} = \text{Liabilities} +

\text{Equity}Assets=Liabilities+Equity
Key Components:

1. Assets:
o Current Assets: Assets that can be converted into cash within one year, such as:
 Cash: Physical currency or money in bank accounts.
 Accounts Receivable: Money owed to the business by customers for sales
made on credit.
 Inventory: Goods available for sale or raw materials.
o Non-Current Assets (Fixed Assets): Long-term assets that will be used for more
than one year, including:
 Property, Plant, and Equipment (PPE): Buildings, machinery, vehicles,
etc.
 Intangible Assets: Non-physical assets like patents or goodwill.
2. Liabilities:
o Current Liabilities: Obligations that must be paid within one year, such as:
 Accounts Payable: Money the business owes to suppliers.
 Short-term Loans: Debts that must be repaid within a year.
o Non-Current Liabilities: Debts that are due after one year, such as:
 Long-term Loans: Bank loans or bonds maturing in more than one year.
 Deferred Tax Liabilities: Taxes owed that are not payable until a future
period.
3. Equity:
o Represents the owner's claim after liabilities have been paid. It includes:
 Capital: Money invested by the owners.
 Retained Earnings: Profits that are reinvested into the business rather
than distributed to owners or shareholders.

Example Layout of Balance Sheet:

Balance Sheet Amount

Assets
- Current Assets $10,000
- Non-Current Assets $40,000
Total Assets $50,000
Liabilities
- Current Liabilities $8,000
- Non-Current Liabilities $12,000
Total Liabilities $20,000
Equity
- Capital $15,000
- Retained Earnings $15,000
Total Equity $30,000
Breakdown: Assets must always equal liabilities plus equity. The balance sheet shows whether a
company is adequately financed through debt or owner's capital.

4. Cash Flow Statement

The cash flow statement outlines how cash moves in and out of a business during a particular
period. It focuses on three main types of activities: operating, investing, and financing.

Key Components:

1. Operating Activities:
o Cash flows from the company’s main business activities. This includes cash
received from sales and cash spent on operations like salaries, rent, and utilities.
o Example:
 Cash inflows from sales: $10,000.
 Cash outflows for salaries: ($3,000).
2. Investing Activities:
o Cash spent on acquiring or selling long-term assets like property, equipment, or
investments. This section shows how much cash was used for growth or
expansions.
o Example:
 Purchase of machinery: ($4,000).
 Sale of old equipment: $1,500.
3. Financing Activities:
o Cash inflows and outflows related to borrowing and repaying loans, or equity
transactions like issuing shares or paying dividends.
o Example:
 Proceeds from a loan: $5,000.
 Dividend payments: ($2,000).

Example Layout of Cash Flow Statement:

Cash Flow Statement Amount

Operating Activities +$6,000
Investing Activities -$2,500
Financing Activities +$3,000
Net Cash Flow $6,500

The Net Cash Flow figure indicates whether the business has a positive or negative cash flow
for the period.
5. Interrelationship Between Financial Statements

Understanding how these statements are linked is crucial. For example:

 The Income Statement affects the Balance Sheet through net income, which increases
retained earnings under equity.
 Cash movements in the Cash Flow Statement affect the cash balance in the Balance
Sheet.

Pictorial Representations

1. Income Statement Breakdown:

This image illustrates the detailed flow from revenue to net profit, with specific sections
for COGS, operating expenses, and net profit.

2. Balance Sheet Visual:

The diagram clearly shows the division between assets on one side, and liabilities and
equity on the other side, highlighting the balancing nature of the balance sheet equation.

3. Cash Flow Diagram:

This diagram explains the inflows and outflows of cash related to operating, investing,
and financing activities.

Summary:

 Financial statements help stakeholders analyze the financial health of a company.

 The Income Statement shows profit or loss.
 The Balance Sheet provides a snapshot of assets, liabilities, and equity.
 The Cash Flow Statement shows how cash is generated and used.