Understanding Financial Statements Flashcards
statement of profit or loss
- measures financial performance
- evaluates business’ ability to make a profit
- shows how much profit/loss has been made in a specific period
- summarises all revenue and expenses
- prepared on an ‘accruals’ basis
key sections of statement of profit or loss: gross profit
gross profit = revenue - cost of sales
- represents the profit made after deducting the costs incurred to manufacture and sell its products/provide services
key sections of statement of profit or loss: operating profit
operating profit = gross profit - operating expenses
- takes account of business expenses which are not directly incurred to generate revenue
- also known as PBIT (profit before interest and tax) or EBIT (earnings before interest and tax)
key sections of statement of profit or loss: profit for the year
profit for the year = operating profit - all other expenses
- the total is transferred to the statement of financial position on a rolling basis each year
- the balance on this account accumulated under the heading ‘retained earnings’
statement of financial position
- measure of the financial position, shows assets and liabilities
- the balance is what belongs to the owners (equity)
- Equity (capital) = assets - liabilities
- snapshot of the position of the company
statement of changes in equity
- summarises the movement in equity balances from. the beginning to the end of the reporting period
- main categories of equity are:
– share capital
– share premium
– retained earnings
statement of cash flows
- summarises the cash paid and received throughout reporting period
(what physically comes in and out) - helps assess liquidity + solvency of the business, financial adaptability of the business, future cash flows and sufficiency of the business
summarised in 3 key sections which help to assess how cash is being generated:
- operating activities
- investing activities
- financing activities
profit does not equal cash flow
cash flow problems –> potential causes
- lack of planning
- overtrading - occurs when business is expanding rapidly without having funds needed
- poor credit control - firm must ensure its customers keep to agreed borrowing limits and pay on time
cash flow problems –> potential solutions
- manage its working cash flows more efficiently
- increase cash sales and/or offer discount for paying in cash
- managing trade receivables to ensure customers pay within agreed credit terms
- monitoring inventory levels
financial statement elements - general info
- financial statements portray the financial effects of transactions and other events (known as ‘items’)
- this is done by grouping them into broad classes called ‘elements’
an item is recognised in the financial statements if:
- the item meets the definition of an element (it meets the definition of income, an expense, asset, liability or equity)
- the item is relevant and a faithful representation
financial statement elements: income
- increases in assets/decreases in liabilities, result in increases in equity other than those relating to contributions from holders of equity claims
financial statement elements: expenses
- decreases in assets/increases in liabilities, result in decreases in equity other than those relating to distributions to holders of equity claims
financial statement elements: asset
- a present economic resource controlled by the entity as a result of past events (an economic resource is a right that has the potential to produce economic benefits - what the business owns/controls)
financial statement elements: liability
- a present obligation of the entity to transfer an economic resource as a result of past events (what the business owes)
financial statement elements: equity
residual interest in the assets of the entity after deducting all liabilities (represents investment by the owner)
