Understanding the Financial Statements
This article is prepared to get an overview of & for the basic study of the financial statements.
In order to understand the financial statements of an organization, one must be aware of the basic accounting concepts, rules, principles & assumptions.
The financial statements are prepared after considering accounting rules, relevant laws and Accounting Standards. However, in order to get a basic understanding, one needs to get an overview of the below-mentioned terms:
At a very basic level, accounting starts with recording a transaction in monetary terms in the books through a journal entry by debiting certain Account(s) & by crediting certain Account(s) with equal Amount(s). Types of Accounts are broadly classified as Real, Personal & Nominal Account & accordingly Journal entries are passed on the basis of three golden rules of accounting after considering the nature of the account. The rules are:
Debit what comes in, Credit what goes out.
Debit the Receiver, Credit the Giver.
Debit all Expenses & Losses, Credit all Incomes & Gains.
The effect of the Journal Entries passed is reflected in the respective ledgers.
A ledger can be termed as a book/account in which all the transactions occurred during a specific period under that particular account, are summarized in monetary terms along with the opening & closing balances.
A Trial Balance is a statement which summarizes the opening & closing balances of all the ledgers as debit or credit balance for a particular period as per the nature of the respective ledgers.
In short & simple way, it looks like a list of all the general ledgers.
The purpose of the Trial Balance is just to display that total debit balance equates total credit balances.
However, it plays a major role in scrutinizing the books as it gives a summary of all the ledgers and many irregularities can be diagnosed from the face of Trial Balance itself.
Trading & Profit & Loss Account:
As the name suggests, a trading account is prepared to calculate & disclose Profit/Loss from trading activity. Such Profit/Loss is termed as Gross Profit/Loss.
Direct Income earned & Direct expenses incurred, during a specified period, forms part of the trading account.
Gross profit/(Loss) is calculated as follows:
Gross profit/(Loss) = Sales – COGS (Opening Stock + Purchases + Direct Expenses - Closing Stock)
Let's understand this formula better with the help of below table:
|COGS (Cost of goods sold)
|Gross Profit/Loss (B-A)
However, Profit & Loss Account calculates & discloses the Net Profit/Loss after adjusting Indirect Incomes & Indirect Expenses from the Gross Profit/Loss.
Indirect Expenses consists of Selling and distribution expenses, Salary, Rent, Freight & carriage on sales, Administrative Expenses, Financial Expenses, Maintenance, Depreciation, Provisions, Interest etc.
Indirect Income may consist of Discount Received, Interest Received, Commission Received, Profit on sale of assets, etc.
A Balance Sheet is a statement that discloses the financial position of an organization as on a particular date. Such financial position is disclosed under 3 Major heads namely Assets, Liabilities & Equity/Capital.
These Major heads are further classified under sub-heads and the disclosure is made as per the requirement of applicable law.
In simple terms, the Balance Sheet shows the appropriation of an organization’s money, valuables, funds, worth & owing under suitable heads.
A Balance Sheet is prepared on the basis of the below mentioned formula:
Assets = Liabilities + Share Capital
It clearly discloses what an organization owns & what it owes on a particular date.
Cash Flow Statement:
As is apparent from its nomenclature, CFS is a statement which discloses the movement of cash & cash equivalents during a particular period.
Such movement is majorly classified into operating, Investing & Financing activities for better disclosure & understanding.
Notes to Accounts:
Notes to the Accounts are prepared for the purpose of further clarity & transparency in financial statements, hence, these form an integral part of the financial statements.
Notes generally make the disclosures as per the requirement of Accounting Standards & applicable laws. Notes also contain information that cannot be mentioned in monetary terms and also the significant accounting policies followed while preparing the financial statements.
*The terms “as on date”, “during the period” & “for the period” shall be read & understood in literal terms while reading this article and shouldn’t be replaced with each other.