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Balance Sheet. Components Analysis

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Balance Sheet. Components Analysis
Table of Contents
  1. Income statement
  2. Retained earnings statement
  3. The cash flow statement
  4. Reference

A balance sheet is a statement of finance that the accounting department prepares to show the financial position of an organization in a given time (Abrams, 2003). The department prepares this statement every financial year. It is also called a fiscal year. A financial year (fiscal year) is any period of twelve months within which a business transacts. Therefore, a financial year can start from any month but ends after twelve months. The balance sheet must have the name of the firm, the date of the statement, title and the units used for measurement.

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Any standard balance sheet must be divided into two parts. The left side is referred to as the debit side and the right side as credit side. Among items that are contained in the balance sheet, there are assets, liabilities and capital.

Assets are items that are valuable to a business or individual and can be converted into cash. They are classified into two categories, which are the current assets and the non-current assets. Current assets are those assets that can be transformed into cash within a period of twelve months and non-current assets are those assets that a firm can hold for more than a year (Abrams, 2003). Examples of current assets are cash and debtors. Examples of non-current assets include land, vehicles, property, plant and equipment.

Liabilities are obligations to a firm that occur due to the past transactions. They are too classified into non-current and current liabilities. Current liabilities refer to obligations that are due in one year while non-current liabilities are due in more than a year (Abrams, 2003).

Capital refers to the amount that is invested in a business by the owners of the business. It is also known as shareholders fund (Abrams, 2003). It includes common stock, reserves, retained earnings and preference shares.

The balance sheet concentrates mainly on the business and not on the owner of the business. Therefore, it has a great importance for the management of the business.

Income statement

This is a financial statement that measures the performance of an entity in a given accounting period. It is also known as the statement of financial performance. Like the balance sheet, an income statement must have a title, name of the business as well as the units of measurement. The items contained in the income statement include sales, which are the total of goods and services that are bought in a given accounting period, cost of sales, which is the total amount incurred in purchasing or manufacturing of good for a resale, and gross profit that refers to the difference between sales and the cost of sales. If the difference is positive, it means the firm is making a profit, but if on the other hand the difference is negative, then it supposes that the firm has made a loss. In addition, the income statement contains the following:

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  1. Expenses. These include selling and distribution expenses as well as administrative expenses.
  2. Operating income referring to the gross profit minus expenses.
  3. Interest expense, which describes the cost that a company incurs on its borrowed funds.
  4. Pretax income. This is the operating income without a deduction of taxes. If the difference is positive, then it is a good indication that the firm is making a profit whereas if the difference becomes negative, it will indicate that the firm is making a loss.
  5. Tax expense, which refers to an estimate of a company‘s expected tax during the covered financial period.
  6. Net income, which can be calculated as a difference between pretax expense and the total sum of taxes. It is the actual profit that a firm has made if the balance is positive. If it turns out to be negative, then it will be the actual loss made in that accounting period.

The income statement is majorly tailored to investors as well as financial analysts. It unveils the expenses and revenues of a firm (Abrams, 2003).

Retained earnings statement

This is a financial statement that reconciles the opening and closing earnings in any given financial period. It starts with the opening retained earning then the net income without dividends is added to obtain the closing retained earnings. Most firms combine it with the income statement to obtain the comprehensive income statement. Retained earnings statement causes interest for directors of the firm so that they can declare dividends to be paid in the particular financial period (Abrams, 2003).

The cash flow statement

This is a financial statement that shows the total cash inflows and total cash outflows of a firm. It analyses all significant changes that occur in cash and cash equivalents, which are grouped into the following categories as (Abrams, 2003):

  1. Operating activities, which consist of cash that is received from customers and cash paid for supplies.
  2. Investing activities, which contain a report on the purchase or sale of long-term assets including property, plant and equipments.
  3. Financial activities that recount any changes that have taken on the capital structure of an entity.

The cash flow serves to consolidate and harmonize the net income. Under normal circumstances, the cash flow from operating activities should be higher than the net income (Abrams, 2003). Therefore, it means that creditors and investors are highly concerned with the cash flow statement.

Reference

Abrams, R. M. (2003). The successful business plan: secrets & strategies (4th Ed.). Palo Alto, Calif.: Running ‘R’ Media.

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