Preparing Financial Statements
Financial statements, though often feared as a very intimidating portion of small business accounting, are just a matter of putting the trial balance amounts onto properly formatted statements. Learn how to prepare these documents you'll need for shareholders, potential financiers and your own insight.
After you have prepared your adjusting entries in the general journal, posted the general journal totals to the general ledger, and footed the general ledger accounts, you are ready to prepare financial statements. Like most of the accounting tasks we've reviewed, your accounting software can alleviate much of the legwork.
If all adjusting entries have been made, and a trial balance done, preparing financial statements is really just a matter of putting the trial balance amounts onto properly formatted statements.
Creating the Components of a Financial Statement
The financial statements prepared for most small businesses comprise a balance sheet and an income statement
Usually these are prepared by an accountant. But with the help of computer software, you may be able to prepare your own financial statements. If you need to prepare financial statements for a third party, such as a banker, sometimes the third party may request that the financial statements be prepared by a professional accountant or certified public accountant.
Preparing a Balance Sheet
Also called a statement of financial position, a balance sheet is a financial snapshot of your business at a given date in time. It lists your assets, your liabilities and the difference between the two, which is your owner's equity, or net worth. The accounting equation (assets = liabilities + owner's equity) is the basis for the balance sheet.
The balance sheet is prepared after all adjusting entries are made in the general journal, all journal entries have been posted to the general ledger, the general ledger accounts have been footed to arrive at the period end totals, and an adjusted trial balance is prepared from the general ledger amounts.
All amounts should be rounded to the nearest dollar, like in this example of a balance sheet for a sole proprietorship:
|Beta Sales Company |
December 31, 201X
|Assets ||Liabilities and Capital |
|Current Assets ||Current Liabilities |
|Cash ||$12,300 || ||Accounts payable ||$ 8,900 || |
|Accounts receivable ||22,900 || ||Wages payable ||11,525 || |
|Inventory ||32,090 || ||Total Current Liabilities ||$20,425 |
|Prepaid Insurance ||2,500 || ||Long-Term Liabilities |
|Total Current Assets ||$69,790 ||Bank Loan Payable ||17,500 || |
|Fixed Assets ||Total Long-Term Liability ||17,500 |
|Equipment ||100,200 || ||Total Liabilities ||37,925 |
|Less: Accumulated Depreciation ||(78,321) || ||Capital |
|Total Fixed Assets || ||21,879 ||Tom Beta, Capital || ||53,744 |
|Total Assets ||$91,669 ||Total Liabilities/Capital ||$91,669 |
For more detailed information on balance sheets and other financial statements, read more about financial statements.
Preparing an Income Statement
Also called a profit and loss statement, or a "P&L," an income statement lists your income, expenses and net income (or loss). The net income (or loss) is equal to your income minus your expenses. Your business's tax return will use a variation of the income statement to determine your potentially taxable income.
The income statement is prepared after all adjusting entries are made in the general journal, all journal entries have been posted to the general ledger, the general ledger accounts have been footed to arrive at the period end totals, and an adjusted trial balance has been prepared from the general ledger totals.
Like financial statements, don't include cents on your income statements that might look something like this:
|Beta Sales Company |
For the Year Ended December 31, 201X
|Sales || |
|Cost of Goods Sold |
|Beginning Inventory ||$ 27,335 || |
|Add: Purchases ||235,689 || |
|Total: ||263,024 || |
|Less: Ending inventory ||32,090 || |
|Cost of Goods Sold || |
|Gross Profit || |
|Advertising ||1,850 || |
|Depreciation ||13,250 || |
|Insurance ||5,400 || |
|Payroll taxes ||8,200 || |
|Rent ||9,600 || |
|Repairs and maintenance ||13,984 || |
|Utilities ||17,801 || |
|Wages ||98,852 || |
|Total Expenses || |
|Net Income || |
|$ 62,581 |
Prepare Closing Entries to Get the Books Ready for the Next Accounting Period
After financial statements are prepared, don't sit on the beach with a pina colada just yet. You need to get your books ready for the next accounting period by clearing out the income and expense accounts in the general ledger and transferring the net income (or loss) to your owner's equity account. This is done by preparing closing entries in the general journal.
The Steps to Closing the Books
Note the distinction between adjusting entries and closing entries. Adjusting entries are required to update certain accounts in your general ledger at the end of an accounting period. They must be done before you can prepare your financial statements and income tax return. Closing entries are needed to clear out your revenue and expense accounts as you start the beginning of a new accounting period.
Preparing your closing entries is a very simple, mechanical process. Follow these steps:
- Close the revenue accounts. Prepare one journal entry that debits all the revenue accounts. (These accounts will have a credit balance in the general ledger prior to the closing entry.) Credit an account called "income summary" for the total.
- Close the expense accounts. Prepare one journal entry that credits all the expense accounts. (These accounts will have a debit balance in the general ledger prior to the closing entry.) Debit the income summary account for the total.
- Transfer the income summary balance to a capital account. Prepare a journal entry that clears out the income summary account. This entry effectively transfers the net income (or loss) of the business to the owner's equity account.
- Close the drawing account. If your business is a sole proprietorship or partnership, close the drawing accounts (if any) by preparing a journal entry that credits the drawing account and debits the owner's equity account.
You have finalized your general ledger and prepared a balance sheet and income statement for the year ended December 31, 2011. You want to get your books ready for next year. You prepare the four closing entries as follows:
|Debit ||Credit |
|Sales ||462,452 || |
|Income summary || |
|To close the revenue account on 12/31/2011 |
|Debit ||Credit |
|Income summary ||399,871 || |
|Purchases || |
|Advertising || |
|Depreciation || |
|Insurance || |
|Payroll taxes || |
|Rent || |
|Repairs and maintenance || |
|Utilities || |
|Wages || |
|To close the expense accounts on 12/31/2011 |
|Debit ||Credit |
|Income summary ||62,581 || |
|Tom Beta, capital || |
|To transfer 12/31/201X net income to the capital account |
|Debit ||Credit |
|Tom Beta, capital ||12,000 || |
|Tom Beta, drawing || |
|To close drawing account for year ended 12/31/201X |
After all closing entries are made, post the entry totals to the general ledger. Foot the general ledger accounts to arrive at the beginning amounts for the new accounting period. All revenue and expense accounts should have a zero balance.
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