Step 4: Income Statement and Balance Sheet
The final step is creating the financial statements. The two most important are the balance sheet and income statement.
- The income statement shows how the business earned and spent its money over the period. Typically, the income statement will show income received then deduct product costs (see step 1), yielding gross profit.
- Gross profit is exactly that- total income minus product costs.
Period costs are then subtracted from gross profit giving the profit (or loss) before taxes. If the company earned a profit, taxes will be subtracted at a flat 16.5 percent rate and give a final profit (rule before progressive tax system implemented).
- The balance sheet examines your business’s position at the end of the period. The balance sheet does this by reporting three categories: assets, liabilities, and equity.
- Assets are resources the company owns that can generate money. Examples include cash, receivables (see step 2), and inventories.
- Liabilities are resources that the company owes. Examples of liabilities are payables (see step 2), debt/loans, and unearned revenue (see step 2).
- Equity is additional value contributed to the business. This value comes in two primary forms retained earnings and contributed capital. Retained earnings is income (or losses) accumulated by the business that is not distributed to shareholders. Contributed capital is value attained in exchange for some amount of ownership of your business.
In accounting, the total assets must equal the total liabilities plus total equity. This formula is called the fundamental accounting equation.
Voila! You just journeyed the four-step accounting process that transformed a cluttered pile of receipts and invoice into useful financial statements.
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