Chapter 2: Financial Statements

Question 1

1. What is a balance sheet?

Answer 1

A balance sheet is a financial statement that shows a company’s assets, liabilities, and equity at a specific point in time. It’s like a snapshot of what the company owns and owes. For example, if a business has $50,000 in assets and $20,000 in liabilities, the remaining $30,000 is equity.

Question 2

2. What is an income statement?

Answer 2

An income statement, also called a profit and loss statement, shows a company’s revenue, expenses, and profit (or loss) over a specific period. For example, it would show that a bakery earned $10,000 in revenue and had $7,000 in expenses, resulting in a $3,000 profit.

Question 3

3. What is a cash flow statement?

Answer 3

A cash flow statement tracks the movement of cash in and out of a business. It’s divided into three parts:
* Operating activities: Day-to-day business operations.
* Investing activities: Buying or selling assets.
* Financing activities: Borrowing or repaying loans.
For example, if a company receives $5,000 in revenue and pays $2,000 in expenses, its net cash flow is $3,000.

Question 4

4. What is a statement of retained earnings?

Answer 4

The statement of retained earnings shows how much profit is kept in the business instead of being distributed as dividends to shareholders. For example, if a company earns $10,000 and keeps $7,000 for reinvestment, it’s reflected in retained earnings.

Question 5

5. What are financial statements used for?

Answer 5

Financial statements help businesses track performance, attract investors, and make informed decisions. For example, a company seeking a loan might use its financial statements to show a bank it can repay the loan.

Question 6

6. What is the difference between tangible and intangible assets?

Answer 6

• Tangible assets are physical items like machinery, buildings, or inventory.
• Intangible assets are non-physical items like patents, trademarks, or goodwill.
  For instance, a factory is a tangible asset, while a brand’s reputation is an intangible asset.

Question 7

7. What are current and fixed assets?

Answer 7

• Current assets: Items that can be converted into cash within a year, like inventory or accounts receivable.
• Fixed assets: Long-term assets used in the business, like buildings or equipment.
  For example, a company’s stock of products is a current asset, while its warehouse is a fixed asset.

Question 8

8. What is equity in a balance sheet?

Answer 8

Equity represents the owner’s share of the business after subtracting liabilities from assets. For example, if a company has $100,000 in assets and $40,000 in liabilities, the equity is $60,000.

Question 9

9. Why is the income statement important?

Answer 9

The income statement is crucial because it shows whether a business is making a profit or loss. For instance, a company can use it to identify areas where costs need to be reduced or revenues increased.

Question 10

10. How do financial statements work together?

Answer 10

Financial statements are interconnected:
* The balance sheet shows the company’s financial position.
* The income statement shows how profitable the business is.
* The cash flow statement tracks the cash movement that supports the other two.
For example, profits from the income statement contribute to equity on the balance sheet.