Understanding Financial Statements:
What do they say about your business?
This workbook is not designed to be your only guide to understanding
financial statements. A much wider range of resources is available to you,
and we strongly recommend you make use of them--everything from books and
other publications to professional organizations and associations to workshops
and training sessions.
The Arkansas Small Business and Technology Development Center, administered by the
University of Arkansas at Little Rock, does not--and cannot--assure that your
business will be successful as a result of implementing the steps outlined in
this workbook.
This material is based on work supported by the U.S. Small Business
Administration under Grant Number SB-BD-92006-01. Any opinions, findings,
conclusions or recommendations expressed in this publication are those of the
author(s) and do not necessarily reflect the views of the U.S. Small Business
Administration.
Introduction
Do you want to be in financial control of your business?
Do you want to know how your "books" work?
Do you want to understand what your accountant tells you?
Do you want to know where to find answers in your financial statements?
If your answers are yes, you will find helpful information in this booklet.
Owning a small business is the dream of many people in our country. These
people have their own ideas for a product or service to provide to the public
or to other businesses. And many of these business people do a very good job
of providing their product or service, but they do not do a good job of
controlling the financial part of their business. It is simply too easy to
devote all of your mental and physical energies to your customers and then do
nothing for yourself.
You must understand that there is no "mystery" to understanding your
business's financial make-up. The same common sense and logic that you apply to
your daily operations will carry you through the steps you need to grasp the
financial information. All that is necessary is for you to learn a few simple
concepts. Master them, and you will no longer be uncomfortable with your
business financial statements.
There are four levels in your business accounting system. They are:
THE FOUNDATION - SOURCE DOCUMENTS AND A FILING SYSTEM
THE INPUT LIST - TRANSACTION JOURNALS
THE CATEGORY LIST - GENERAL LEDGER
THE MANAGEMENT REPORT - FINANCIAL STATEMENTS
The purpose of this book is to help you understand that these four levels of
information contain everything you need to comprehend the financial condition
of your business. Let's consider these four areas one at a time.
Level One
The Foundation - Source Documents and a Filing System
In order to work with your accounting information, you must know what type
of documents create your accounting information and where you can find those
documents in your office. Examples of accounting documents are:
Sales invoices or tickets
Deposit tickets
Paid bills
Bank statements
Canceled checks
Employee earnings records
Monthly, quarterly and annual payroll reports
Monthly sales tax reports (if applicable)
Detailed accounts receivable and accounts payable lists
These documents are the raw materials from which your books and financial
statements are constructed, and they give rise to the first axiom of financial
understanding.
Axiom 1
To be able to validate your financial statements, you must be able to verify
any items on them from the applicable source documents.
You or your bookkeeper should have an organized system of filing these
documents. Some are filed numerically, some chronologically, some alphabetically,
but all must be filed promptly and consistently. The worst enemy in your office
is your inability to find something when you need it. Although the daily
responsibility may be a bookkeeper's or a clerk's, as the owner, you must know
where everything is and what it means. Give up that responsibility and you are
inviting a short business career.
Special Discussion - Bank Reconciliation
Bank reconciliation is done monthly after receiving a bank statement and
canceled checks. Reconciling your bank balance verifies the accuracy of your
checkbook, but you must also ensure that the bank balance in your books agrees
with the reconciled checkbook balance. This ensures that your books and your
financial statements include all of your deposits, checks and other charges to
your account such as automatic payments.
If you do not personally do the bank reconciliation, you should physically
review it each month and spot check the reconciliation to the bank statement
itself. Always open the statement and check the ending bank balance with the
"balance per bank" amount on the reconciliation. Also, review the list of
outstanding checks, and if any are on the list for two months or more, find out
to whom they were written. Do not make it easy for a bookkeeper to be dishonest
by not checking for yourself. If you have an outside bookkeeper or accountant
reconcile your bank statement, you add another level of security to your system.
Axiom 2
It is your responsibility to ensure that your bank balance is reconciled each
month and that the bank balance in your books and financial statements agree
with the reconciled balance.
Level Two
The Input List - Transaction Journals
The transaction journal is the entry point into your accounting system.
Whether your system is manual or computerized, your sales, checks, deposits,
adjustments, etc. are first listed in a sequential list showing the transaction
date, number, amount, description and the account name or number to which the
transaction has been assigned. Deposits are usually listed in date sequence, and
sales invoices, checks, vouchers, etc. are listed numerically. Transaction
journals are monthly reports, so if you know the date or number of the
transaction, you can find the point at which it entered your accounting system
and where it went.
Your accounting system, whether it is your own internal system or that of a
service bureau or bookkeeping or accounting service, should always include one
or more transaction journals. Some accounting systems group all transactions
together into a single journal, and some have separate journals for each type
of transaction, such as sales, disbursements, etc. The style is not of primary
importance; that its available to you in a regular, consistent format is.
Axiom 3
To discover where a specific transaction such as a check or a deposit will
show in your books and financial statements, go to the appropriate transaction
journal and find the entry in the sequential list of transactions.
Level Three
The Category List - General Ledger
The general ledger is a cumulative (year-to-date) book (for a manual system)
or report (for a computerized system) that shows the balances in each of your
accounts. Your accounting system is built around a list of account names
called a chart of accounts, organized under the following categories:
Assets
Liabilities
Capital (Owner's Equity)
Income
Cost of Sales (for a business that sells a product)
Operating Expenses
Other Income (Expenses)
It is important to understand these categories. You must know what to find
in each category and understand what order they are listed in to be able to
find them in your general ledger (and later in your financial statements).
Consider the following informal definitions:
Assets - The physical items that your business owns including money,
receivables, investments, buildings, equipment, etc.
Liabilities -Those amounts that your business owes to third parties. They
include payables, notes, mortgages, taxes, owner loans (not owner investments),
etc.
Capital - The investments of the owners and the accumulation of profits or
losses for the business since it began.
Income - The sources from which the business earns its money. Income is
measured for a period of time.
Cost of Sales - The cost of the product sold by a business and the related
costs of having the product available to sell. In some instances service-technician
labor is included in cost of sales along with the product sold. Cost of sales
is measured for a period of time.
Operating Expenses - The daily expenses incurred in running your business.
They are the rent, advertising, insurance, etc. Operating expenses are measured
for a period of time.
Other Income (Expense) - These are a part of doing business, but are not
daily necessities or a required part of operations. Examples include bad debts
recovered, interest income and expense, discounts earned, insurance on corporate
officers, etc. Consult with your accountant for more information. Other income
and expenses are measured for a period of time.
Your general ledger will have the categories grouped in the order listed
above. If your accounting system is computerized, you should have a "detailed
general ledger" in which every transaction for each category is listed. This is
ideal for tracing transactions through your books. If you do not have a detailed
general ledger, or if you have a manual set of books, there should be an entry
in each general ledger account that refers back to one or more transaction
journals. These entries allow you to locate specific transactions that were
classified into the various general ledger accounts. The general ledger is an
output-oriented report. In other words, you analyze the general ledger from the
end product (the category or account name) back to the source transaction. This
leads to Axiom 4.
Axiom 4
To analyze your business by questioning what is in a specific account, begin
with the general ledger and trace backwards through the transaction journal
until you get to the source documents.
The general ledger, then, contrasts with the transaction journal, which is
an input-oriented report. To get into the journals you must identify the source
transaction. Your question relates to where in your books the transaction was
posted. The output-oriented general ledger, on the other hand, begins with an
account balance, and your question relates to what items have been posted to a
specific account.
Your general ledger and transactions journals are the building blocks upon
which your financial statements are constructed. Many of the answers you seek
when you analyze your financial statements will be found in the journals and
ledger. It is crucial that you understand their role in your accounting system.
Level Four
The Management Report - Financial Statements
We have now arrived at the point that you've been waiting for - how to
understand your financial statements. It is important, however, that you study
and understand the material you have already read, because understanding your
financial statements depends on being able to move comfortably from your source
documents through your journals and ledgers.
Every time you have statements prepared, whether monthly, quarterly or
annually, you should receive the following two primary financial statements:
Income Statement
The income statement will tell you if you made a profit or a loss for a
specific accounting period (month, quarter, year, etc.)
The income statement is the one you always look at first. Its purpose is to
show you if you made a profit or a loss. The income statement is designed to
give you information about the accounts in your accounting system that fall in
the categories of income, cost of sales, operating expenses and other income
(expense). The income statement measures results for a period of time.
Balance Sheet
The balance sheet will tell you how you have managed the assets and
liabilities of your business. It will show if you are a good steward with your
money.
The balance sheet is the statement you seldom look at because you may not
understand what it is telling you. The purpose of the balance sheet is to show
you what the business owns, what it owes, and what the difference - or its
capital - is. It is designed to give you information about the accounts in
your accounting system that fall in the categories of assets, liabilities and
capital (owner's equity). The balance sheet describes a specific date in time.
You will find examples of balance sheets and income statements in Appendix A.
Turn now to A2 - A5 and look at them. We will talk next about where to look to
find answers to your specific questions. Later we will review some specific
techniques to emphasize relationships within the two statements.
The Secret of Understanding Financial Statements
When reading your financial statements is new to you, most of what you see is
strange. If you are unable to find something that makes sense quickly, you are
likely to lose interest and turn to something that you like or understand
better. But the positive financial impact that a thorough review of your
statements will have on your business is crucial. This leads to Axiom 5.
Axiom 5
When looking at financial statements, ask questions that will eliminate 50
percent of your alternatives first, thus, reducing your confusion and reducing
the time it takes to address your concerns.
The first thing you must do when you are unfamiliar with analyzing financial
statements is to ask the following question:
Q: Is the item I am asking about part of the profit or loss of my business,
or is it part of what it owns and what it owes?
A: If your question is about profit or loss like income, cost of sales,
operating expenses or other income (expense), you want the income statement.
OR A: If your question is about assets, liabilities, or capital (owners'
equity), you want the balance sheet. Now that you have eliminated 50 percent
of your financial statement alternatives, let's look at the composition of each
statement so that we can further limit our alternatives.
Income Statements
Income statements will be organized like this:
Income
Cost of Sales
Gross Profit (a total of income less cost of sales)
Operating Expenses
Net Operating Income (a total of gross profit less operating expenses)
Other Income (Expense)
Net Income (a total of net operating income plus or minus other income)
Look at the categories that have the dots beside them. They are from your
general ledger. By classifying your question under one of those four areas, you
can effectively eliminate 75 percent of the income statement. Now you can set
about finding the answer to your question.
Example
Say you had a question about an advertising expense, what would you do? Your
thought process would be something like this:
1. My question is about advertising. Is that part of profit and loss or part
of what I own and what I owe (assets and liabilities)?
2. Is advertising part of income, cost of sales, operating expenses or
other income and expense?
It is not income. It is not cost of my product sold. It is not other income
(expense), because it is a normal part of operations. Therefore I can ignore
the other three parts of the income statement and concentrate on operating
expenses.
With two simple questions you can narrow your search down to a single part
of a financial statement. Now, if you wanted to know what was in advertising
expense, using what you learned earlier in this booklet, you would go to the
general ledger and through the transaction journal and possibly all the way
back to your filed source documents to find a paid bill for a specific
advertising expense.
The first part of analyzing your own financial statements is being able to
decide quickly where to look, and then to be able to work backwards through the
general ledger to identify any income or expense item about which you have a
question.
Now look again at the income statement in Appendix A and review the
individual account names. Compare them against your own financial statements.
If necessary, visit with your own accountant and learn how each account is used
and what you can expect to find in it. Your responsibility is to become familiar
with your own income statement and learn what to expect as you read and study it.
Balance Sheets
Balance sheets are usually organized from the top of a page down and usually
look like this:
Assets
Current Assets
Fixed Assets (Property, Plant and Equipment)
Other Assets
Liabilities
Current Liabilities
Long-term Liabilities
Capital (Owner's Equity)
The major categories above are from the categories of accounts that are
in your general ledger. Each of these categories has specific characteristics,
and by narrowing your question to one of these areas, you can limit the amount
of work you must do to answer your question. Here are some simple definitions:
Current Assets - Assets that either are cash now or will become cash within
the next 12 months. Examples are bank accounts, accounts receivable,
inventories, etc.
Fixed Assets - The things you own for the purpose of producing income.
Examples are buildings, vehicles, equipment, furniture, computers, etc.
Other Assets - The things you own that do not fit in the above two categories.
Examples are patents, copyrights, utility deposits, etc.
Current Liabilities - Amounts you owe that must be paid within the next
twelve months. Examples are trade accounts payable, sales and payroll taxes,
income taxes and the next 12 payments for your notes and mortgages.
Long-term Liabilities - Amounts you owe that will be paid after the next 12
months. These are usually confined to all payments on your notes and mortgages
due after the next 12 months.
Capital (Owner's Equity) - The investment made by the owner, less any capital
withdrawals, plus all accumulated earnings of the company since inception.
Look again at the balance sheet in Appendix A and become familiar with the
captions and the descriptions that go under each one.
Example
Suppose your question concerns amounts you owe your customers for trade
accounts payable.
1. I owe my customers for trade accounts payable. Is that part of profit or
loss or what I own and what I owe (assets and liabilities)?
Accounts payable are part of what you owe, which are shown on the balance sheet.
2. Are accounts payable assets or liabilities?
Trade accounts payable are liabilities and are due within the next 12 months.
Look in the current liabilities section of the Balance Sheet.
With these two questions you have narrowed your search first to the balance
sheet, and then to the specific section of the balance sheet. Now you can trace
through the general ledger, the transaction journal, the subsidiary list or
report of accounts payable, and, if necessary, the paid bills files to answer
your question.
Let's consider the balance sheet a little further. We have already established
that it represents a report that shows what your business owes and what it owns.
In more formal terms it discloses your assets, liabilities and capital. All of
these are real-world numbers. This leads us to Axiom 6.
Axiom 6
Every number on your balance sheet represents some specific thing your business
owns or owes. This means that you should be able to verify every number on your
balance sheet from a source document in your office.
Chances are you seldom, if ever, look at your balance sheet with the goal of
understanding where the numbers come from. You should take up the project of
tracing every number on your balance sheet to its origin. This is the only way
that you can be sure that your statement is accurate. If you have done your own
homework and learned how your office is organized and where your source documents
are filed, you should be able to do this. Insist that any errors you find be
corrected and explained to you. Do not let someone convince you that this is
not important! You are working very hard to run your business and make a profit.
You are entitled to accurate financial statements. Go for it!
Conclusion
At this level of understanding your financial statements, you should be able
to determine quickly which statement to look at to answer whatever your question
is. Once you identify the statement, and more specifically the part of the
statement you want, then you will also want to identify the transactions that
were posted to the account or accounts in question. By understanding the role
and relationship of your general ledger (the category list), the transaction
journals(the input list) and your original source documents and their physical
location in your office, you will be able to answer any question you have about
what is in your books and where it is reported. If you do not understand why
something is posted where it is, then it is your duty and responsibility to ask
your bookkeeper or your accountant. The books are yours, and you must have
final approval.
Advanced Financial Statement Analysis
The next step in your journey through your financial statements is to learn
how to draw management information from them to evaluate your company's
strength and your effectiveness as a manager. The concept we will use for this
is called ratio analysis. Ratio analysis is the process of identifying certain
numbers from your financial statements, making a mathematical calculation with
them and then evaluating the results. In the previous section you were identifying
specific numbers on your statements and learning how to verify them to be sure
that your statements were totally accurate. Now you will draw management conclusions
from your statements. We will look at ratios in the following three categories:
As we work our way through several financial ratios, you will see how they
take certain numbers from the financial statements and calculate a number that
can be used as a management tool. However, calculating a ratio is not an end in
itself and is of no value to you. Here comes another axiom!
Axiom 7
A ratio by itself is meaningless until it is compared to a standard. The
standard may be your own prior period ratios, industry averages or your own
projections and goals.
The benefit of ratio analysis is that it provides a benchmark to measure
performance, target future goals and help identify patterns and problem areas.
First let's consider sources of comparative data. The best are outside sources
such as the following:
You can contact several sources to search for comparative financial ratios.
The first is your local, state or national trade association. The second is the
loan officer at your bank. The third is a library. The larger public libraries
will have reference materials and will also have indexes of magazine articles
that contain financial information. You can also look to college and university
libraries for similar information. Finally, you can contact the information
specialist at the Arkansas Small Business and Technology Development Center for leads on
comparative financial ratio information for your type of business. You will
usually be able to find information organized by type of business, size of
business and geographic location.
Once you find a source for comparative ratios, or if one is unavailable and
you decide to use your own historical ratios, you will need to decide on a way
to organize and present your information. Some small business owners make a
fill-in-the-blank form they use each month to calculate their ratios and compare
them against standards or prior periods. Others plot them on graph paper. Ratios
lend themselves well to computerized spreadsheets such as Lotus 123, Excel and
many others. If you like spreadsheets, you can enter your data and have both a
report and a series of graphs or charts printed. The choice is yours. The
important thing is that you regularly calculate your ratios and review them.
Let's look at three types of ratios. Sample calculations of all the following
ratios appear in Appendix B.
Liquidity Ratios
A liquidity ratio measures some aspect of your company's proportion of cash
and other liquid assets and short-term liabilities. Because his ratio considers
only assets and liabilities, all of the numbers will come from your balance sheet.
Since all cash and near cash assets will become cash within the next 12 months,
and since all of the liabilities considered are due within the next 12 months,
all of these items are further isolated within current assets and current
liabilities.
Four important liquidity measurements are:
1. Working Capital = Total Current Assets - Total Current Liabilities
The number that represents working capital should be a positive number, that
represents short-term unencumbered capital. It is important for any business to
have unencumbered cash balances. This is the short-term capital a business
uses for day-to-day operations, for taking advantage of purchase discounts, for
making payrolls, etc.
Look for a positive working capital difference, the larger the better. Look
for consistency and growth over time.
2. Current Ratio =
This ratio represents the number of times your current assets will pay your
current liabilities. Therefore, you want the ratio to be at least one. A ratio
of less than one indicates more current liabilities than current assets, which
is not good. A ratio of two indicates twice as many current assets as current
liabilities. That is good.
Look for a positive dividend, the larger the better. Look for consistency
and growth over time.
3. Acid Test Ratio =
(Quick Ratio)
This ratio carries the same logic as the current ratio, but it is a more
conservative ratio. With only cash and accounts receivable as the numerator,
essentially fewer liquid assets are available to pay current liabilities. The
resulting ratio will be lower than the current ratio.
Look for a positive dividend, the larger the better. Look for consistency
and growth over time.
4. Inventory to Working Capital Ratio =
This ratio indicates the percentage of working capital made up of inventory.
It will be expressed as a percentage, since it will be less than one. Inventory
is a current asset, but it is not as liquid as cash or accounts receivable.
Look for a low percentage, the smaller the better. Look for consistently
lower percentages over time.
Take a moment now to look at the balance sheet in Appendix A, specifically
at the current assets and current liabilities. Become familiar with the items
shown there. Then look at these four ratios, and think about what they mean
logically, not the formulas. Logically they are telling you that to be successful
you must have unencumbered liquid assets and that you must have more liquid
assets than short-term liabilities. Become familiar with the concept of working
capital, because you simply cannot run a successful business without positive
working capital.
These four ratios highlight the use of common sense and good judgment to be
sure you have enough money to pay your bills. By analyzing the change in these
ratios over time you can track your progress toward financial stability and
measure your business against industry standards.
Profitability Ratios
Profitability ratios measure various aspects of your company's ability to
generate good profits. They consider only income, cost and expense accounts;
accordingly, only the income statement is used for these ratios. Look again at
the income statement in the Appendix A and become familiar with the various
classifications and accounts displayed under each classification. Profitability
ratios will be expressed as percentages. All these ratios will be displayed on
an income statement.
1. Gross Profit Percentage =
The gross profit percentage represents the proportion of your sales dollar
that is left over after the cost of your product is deducted to pay operating
expenses and result in a profit.
Work to make this percentage increase over time. A higher percentage is
better.
Axiom 8
The single most important percentage on your income statement is the gross
profit percentage. The battle for success in your income statement is won or
lost there You should know the percentage by memory and understand why it is
what it is and what causes it to change.
2. Operating Expense Percentage =
This ratio can be calculated for total operating expenses or for each
operating expense individually. It is used to control operating expenses.
Look at the percentages and work to decrease them. Work consistently to get
your expenses to become a lower proportion of your revenues.
3. Net Income before Tax Percentage =
This ratio shows the proportion of your sales dollar that remains for profit
after all expenses except income taxes.
Work to increase this percentage.
Efficiency Ratios
Efficiency ratios measure your effectiveness in managing two of the most
important areas of your small business - accounts receivable and inventory.
Any business can tie up a lot of money in receivables and inventory. Unless
these two areas are monitored with objective standards such as these ratios,
the amount of money invested can get out of hand quickly.
1. Accounts Receivable Turnover =
This ratio indicates the number of times your accounts receivable turns
over into cash during the year. It measures the effectiveness of your credit
terms and collection procedures.
Work to increase the turnover number.
2. Accounts Receivable Collection Period =
This ratio shows the average length of time in days from sale to collection
of your accounts receivable.
Work to reduce the number of days in your collection period.
3. Inventory Turnover =
This ratio indicates the number of times your inventory turns over during
the year. It helps to measure the effectiveness of your purchasing and
inventory control procedures.
Work to increase the turnover number.
4. Days Inventory on Hand =
This ratio indicates the average number of days it takes to sell your
inventory.
Work to lower the days-on-hand number.
5. Operating Cycle =
This number, expressed as a number of days, represents the amount of time
from the purchase of inventory to the collection of cash from your sales.
Work for a lower number. A higher number requires more working capital.
These ratios are not intended to be all inclusive, but they are a good
"starter set" for you. When you have the opportunity to review ratios available
from your trade association, your banker, your accountant or other sources, by
all means use them.
Action Steps
Now that you have completed this booklet, you have one more set of tasks
before you can properly use your newly acquired knowledge about your accounting
system and financial statements.
1. Make a three-ring binder with monthly tab dividers to file your monthly
financial statements.
2. Ensure that you are provided a balance sheet, income statement, a
detailed general ledger and transaction journals with your financial statements.
3. Set up a monthly time to review your business financial statements and
to review your goals and plans.
4. Learn and understand the purpose of the balance sheet and the income
statement and learn to use each for evaluating your business.
5. Learn how all of the numbers on your financial statements can be traced
and verified.
6. Set up a worksheet to track your percentages and ratios each month.
7. Obtain comparative financial information from a trade association,
your banker, the Arkansas Small Business and Technology Development Center, your CPA or some
other source to use with your own financial information and ratios.
Appendix A - Sample Financial Statements
ABC Company, Inc.
Balance Sheet
December 31, 1993
| Assets |
| Current Assets |
| Cash |
$5,368 |
| Marketable Securities |
3,090 |
| Accounts Receivable |
235,382 |
| Inventory |
262,582 |
| Prepaid Expenses |
2,870 |
| Total Current Assets |
$509,292 |
| |
| Property, Plant & Equipment |
| Land |
$4,520 |
| Building |
78,540 |
| Less: Accumulated Depreciation |
(30,696) |
| Equipment |
18,907 |
| Less: Accumulated Depreciation |
( 7,980) |
| Total Property, Plant and Equipment |
$ 63,291 |
| |
| Total Assets |
$572,583 |
| |
| Liabilities and Stockholders'
Equity |
| Current Liabilities |
| Accounts Payable |
$224,235 |
| Accrued Expenses |
9,758 |
| Income Tax Payable |
2,040 |
| Current Portion L/T Debt |
3,000 |
| Total Current Liabilities |
$239,033 |
| |
| Long-Term Liabilities |
| Mortgage Payable |
$25,000 |
| Bank Note Payable |
5,000 |
| Total Long Term Liabilities |
$30,000 |
| |
| Total Liabilities |
$269,033 |
| Stockholder's Equity |
| Common Stock ($1 Par) |
$ 10,500 |
| Retained Earnings |
293,050 |
| Total Equity |
$303,550 |
| |
| Total Liabilities and Equity |
$572,583 |
ABC Company, Inc.
Comparative Balance Sheets
As of December 31, 1993
| |
1993 |
1992 |
| Assets |
| |
| Current Assets |
| Cash |
$5,368 |
$ 6,574 |
| Marketable Securities |
3,090 |
1,570 |
| Accounts Receivable |
235,382 |
232,936 |
| Inventory |
262,582 |
210,434 |
| Prepaid Expenses |
2,870 |
2,590 |
| Total Current Assets |
$509,292 |
$494,104 |
| |
| Property, Plant & Equipment |
| Land |
$4,520 |
$4,300 |
| Building |
78,540 |
78,540 |
| Less: Accumulated Depreciation |
(30,696) |
(29,196) |
| Equipment |
18,907 |
16,717 |
| Less: Accumulated Depreciation |
( 7,980) |
( 7,840) |
| Total Property, Plant and Equipment |
$63,291 |
$62,521 |
| |
| Total Assets |
$572,583 |
$556,625 |
| |
| Liabilities and Stockholders'
Equity |
| Current Liabilities |
| Accounts Payable |
$224,235 |
$230,353 |
| Accrued Expenses |
9,758 |
6,137 |
| Income Tax Payable |
2,040 |
1,425 |
| Current Portion L/T Debt |
3,000 |
3,000 |
| Total Current Liabilities |
$239,033 |
$240,915 |
| |
| Long-Term Liabilities |
| Mortgage Payable |
$ 25,000 |
$ 28,000 |
| Bank Note Payable |
5,000 |
|
| Total Long Term Liabilities |
$30,000 |
$ 28,000 |
| |
| Total Liabilities |
$269,033 |
$268,915 |
| Stockholder's Equity |
| Common Stock ($1 Par) |
$ 10,500 |
$ 10,000 |
| Retained Earnings |
293,050 |
277,710 |
| Total Equity |
$303,550 |
$287,710 |
| |
| Total Liabilities & Equity |
$572,583 |
$556,625 |
XYZ Company, Inc.
Income Statement for the year ended December 31, 1993
| Income |
| Sales |
$2,102,358 |
| |
| Cost of Sales |
| Beginning Inventory |
$ 331,764 |
| Purchases |
1,469,825 |
| Other Costs |
136,003 |
| Goods Available for Sale |
$1,937,592 |
| Less: Ending Inventory |
(501,575) |
| Cost of Sales |
$1,436,017 |
| |
| Gross Profit |
$ 666,341 |
| |
| Operating Expenses |
| Advertising |
$ 4,341 |
| Auto & Truck |
8,264 |
| Bad Debts |
807 |
| Bank Charges |
110 |
| Casual Labor |
3,586 |
| Commissions |
41,298 |
| Contributions |
1,194 |
| Depreciation |
16,658 |
| Dues & Subscriptions |
1,925 |
| Entertainment |
10,181 |
| Equipment Rent |
6,601 |
| Fuel |
13,133 |
| Insurance |
50,788 |
| Janitorial Service |
4,299 |
| Leasing |
11,688 |
| Legal & Accounting |
1,911 |
| Miscellaneous |
41,124 |
| Office Supplies |
12,711 |
| Rent |
19,246 |
| Repairs & Maintenance |
4,533 |
| Salaries |
238,674 |
| Shop Supplies |
10,097 |
| Taxes - General |
3,643 |
| Taxes - Payroll |
19,269 |
| Telephone |
14,119 |
| Travel |
8,981 |
| Utilities |
8,165 |
| Total Operating Expenses |
$557,356 |
| |
| Net Operating Income |
$108,985 |
| |
| Other Income (Expense) |
| Discounts Earned |
$2,915 |
| Discounts Allowed |
(3,385) |
| Interest Expense |
(43,759) |
| Total Other Income (Expense) |
$44,529 |
| |
| Net Income |
$64,456 |
XYZ Company, Inc.
Comparative Income Statements
For The Years Ended Dec. 31, 1992 and Dec. 31, 1993
| Income |
1993 |
1992 |
| Sales |
$2,102,358 |
100.0% |
$2,006,888 |
100.0% |
| |
| Cost of Sales |
| Beginning Inventory |
331,764 |
15.8 |
146,078 |
7.3 |
| Purchases |
1,469,825 |
69.9 |
1,569,161 |
78.2 |
| Other Costs |
136,003 |
6.5 |
67,771 |
3.4 |
| Goods Available for Sale |
$1,937,592 |
92.2 |
$1,783,010 |
88.9 |
| Less: Ending Inventory |
501,575 |
23.9 |
331,764 |
16.5 |
| Cost of Sales |
$1,436,017 |
68.3 |
$1,451,246 |
72.4 |
| |
| Gross Profit |
$666,341 |
31.7 |
$555,642 |
27.6 |
| |
| Operating Expenses |
| Advertising |
$4,341 |
.2 |
$7,444 |
.4 |
| Auto & Truck |
8,264 |
.2 |
3,990 |
.2 |
| Bad Debts |
807 |
|
385 |
|
| Bank Charges |
110 |
|
66 |
|
| Casual Labor |
3,586 |
.2 |
11,149 |
.6 |
| Commissions |
41,298 |
2.0 |
37,987 |
1.8 |
| Contributions |
1,194 |
.1 |
420 |
|
| Depreciation |
16,658 |
.8 |
13,636 |
.7 |
| Dues & Subscriptions |
1,925 |
.1 |
1,480 |
.1 |
| Entertainment |
10,181 |
.5 |
2,287 |
.1 |
| Equipment Rent |
6,601 |
.3 |
|
|
| Fuel |
13,133 |
.6 |
10,119 |
.5 |
| Insurance |
50,788 |
2.4 |
38,346 |
1.8 |
| Janitorial Service |
4,299 |
.2 |
1,540 |
.1 |
| Leasing |
11,688 |
.6 |
19,115 |
1.0 |
| Legal & Accounting |
1,911 |
.1 |
7,934 |
.4 |
| Miscellaneous |
41,124 |
2.0 |
2,821 |
.1 |
| Office Supplies |
12,711 |
.6 |
8,759 |
.4 |
| Rent |
19,246 |
.9 |
13,683 |
.7 |
| Repairs & Maintenance |
4,533 |
.2 |
11,270 |
.6 |
| Salaries |
238,674 |
11.2 |
228,444 |
11.4 |
| Shop Supplies |
10,097 |
.5 |
6,098 |
.3 |
| Taxes - General |
3,643 |
.2 |
3,704 |
.2 |
| Taxes - Payroll |
19,269 |
.9 |
23,242 |
1.2 |
| Telephone |
14,119 |
.7 |
12,066 |
.6 |
| Travel |
8,981 |
.4 |
12,838 |
.6 |
| Utilities |
8,165 |
.4 |
7,885 |
.4 |
| Total Operating Expenses |
$557,356 |
26.5% |
$486,708 |
24.2% |
| Net Operating Income |
$108,985 |
5.2% |
$68,934 |
3.4% |
| |
| Other Income (Expense) |
| Discounts Earned |
$2,915 |
.1% |
$1,695 |
.1% |
| Discounts Allowed |
( 3,385) |
( .2) |
( 7,804) |
( .4) |
| Interest Expense |
(43,759) |
( 2.0) |
(22,835) |
( 1.2) |
| Total Other Income (Expense) |
$44,529 |
(2.1) |
$28,944 |
( 1.5) |
| |
| Net Income |
$64,456 |
3.1% |
$39,990 |
2.0% |
Appendix B - Sample Ratio Calculations
Liquidity Ratios
Working Capital
Total Current Assets - Total Current Liabilities
$ 509,292 - $ 239,033 = $ 270,259
Working capital is $ 270,259. Current Ratio
Current Ratio = 2.1
Acid Test Ratio
Acid Test Ratio = 1.04
Inventory to Working Capital
Inventory to Working Capital = .98
Profitability Ratios
Gross Profit Percentage
Gross Profit / Net Revenue = $ 666,341 / $2,102,358
Gross Profit Percentage = 31.7%
Note that this percentage is already calculated on the
income statement shown on page A-5. An income statement that
shows these percentages is an excellent management tool and
is standard on most computer software packages used for
bookkeeping.
The operating expense percentages and net income before tax percentages are
also shown on the statement on page A-5. For that reason they are not
calculated individually here.
Efficiency Ratios
Accounts Receivable Turnover
(Assume all sales are credit sales)
Credit Sales / Average Accounts Receivable
Accounts Receivable Turnover is 8.98.
Accounts Receivable Collection Period
Accounts Receivable Collection Period is 40.65 days.
|
