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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

    Lawn Cutting Revenue $845
    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
    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

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
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