Chapter 9Financial Statements for a Sole Proprietorship

Chapter 9 Objectives• Explain the purpose of the Income Statement• Prepare an Income Statement

• Explain the purpose of the Statement of Changes in Owner’s Equity

• Prepare a Statement of Changes of Owner’s Equity

• Explain the purpose of a Balance Sheet• Prepare a Balance Sheet

• Explain the Purpose of the Statement of Cash Flows• Explain the ratio of analysis and compute ratios

What do you think?• What information would owners, managers, and investors

want to know about a business?• Types of transactions the business has• The monetary changes occurred for the period• Whether there was a profit or loss

• How do people who read financial statements use the information?• Financial Statements provide essential information for making

sound decisions.

Chapter 9.1 Objectives• Learn the four financial statements prepared for a business• How to prepare an Income Statement

Financial Statements• Summarize the changes resulting from business transactions

that occur during the accounting period• Preparing Financial Statements is STEP #7 in the Accounting

Cycle

Four Financial Statements

All derived from the Work Sheet• Income Statement• Balance Sheet• Statement of Changes in Owner’s Equity• Statement of Cash Flows

The Income Statement• Reports net income and/or net loss of a business for a

specified period of time• Also called, Profit-and-Loss Statement, or an Earnings

StatementRoadRunner Delivery Service

Income StatementFor the Month Ended October 31, 2013

% OF

SALES

Revenue: Delivery Revenue $ 2,650.00 Expenses: Advertising Expense $ 75.00 5.0% Maintanience Expense $ 600.00 40.0% Rent Expense $ 700.00 46.7%

Utlitlies Expense $ 125.00 10.9%

Total Expenses $ 1,500.00

Net Income: $ 1,150.00

Income Statement Sections• Heading• Revenue for the period• Expenses for the period• Net Income and/or Net Loss for the period

Income Statement Sections: Heading• Who?• What?• When?

Income Statement Sections: RevenueGive some examples of sources of revenue the Walt Disney company might have.A. Write Revenue: on the first line at the left side of the formB. Enter the revenue account names beginning on the 2nd line,

indented about ½” from the left edgeC. Enter the balance of each revenue account in the 1st amount

column• Enter the total revenue in the 2nd amount column beneath the

last revenue amount and write Total Revenue to the left• If there is only one revenue account, no Total Revenue is needed

and you can simply write the amount in the 2nd column

Income Statement from Work Sheet: Revenue

Income Statement Sections:ExpensesD. On the line following the revenue section, write Expenses: at

the left sideE. Enter expense account names beginning on the next line

and enter the balances in the 1st amount columnF. Single rule under the balanceG. Write Total Expenses on the line under the last expense

account nameH. Add the balances for the expense accounts and enter the

amount in the 2nd amount column under the last expense account balance

Income Statement from Work Sheet: Expenses

Income Statement Sections: Net Income/Net LossIs this the first time we have calculated Net Income or Loss? If not, where have we calculated this amount before?

I. Draw a single rule under the total expenses accountJ. Subtract the total expenses from the total revenue and

enter the value in the 2nd amount column under the total expenses amount

K. To the left of this value, write Net Income (Loss)L. If this amount matches the amount on the work sheet,

double rule beneath the net income amount

Income Statement from Work Sheet

Income Statement: Reporting a Net Loss• If total expenses are greater than total revenue, a net loss

exists• To Record a Net Loss• Enter the net loss amount in the 2nd amount column beneath the

total expenses amount• Write Net Loss to the left of this value

Closure Ticket

Answer the following questions:1. What are the primary financial statements for a sole

proprietorship?2. What are the Income Statement sections?3. What are other names for the Income Statement?4. What period other than a month does the Income

Statement cover?

To Do• 9.1: Text p. 224, Wbk p. 164• 9.4: Text p. 242, Wbk p. 165-166

What do you think?• What decisions would an owner make based on the changes in

owner’s equity for a period?• Whether an increase meets expectations• What to do if OE decreased• Whether the owner can continue to make withdrawals at the

same amount, etc

Chapter 9.2 Objectives• The purpose of the statement of changes in owner’s equity• How to prepare a statement of changes in owner’s equity

The Statement of Changes in Owner’s Equity• Summarizes the changes in the owner’s capital account as a

result of business transactions that occur during the period• Balances of revenue, expenses, and the owner’s withdrawal

account transfer to the owner’s capital account• Prepared at the end of the period• Information to prepare this statement is found in• The work sheet• The income statement• The owner’s capital account in the GL

• Use standard 3 line heading,• Company - WHO• Statement of Changes of Owner’s Equity - WHAT• For the month ended Dec 31, 2013 - WHEN

The Statement of Changes in Owner’s EquityA. On the first line, write Beginning Capital, followed by a

comma and the first day of the periodB. Enter the balance of the capital account in the 2nd column,

found in the GLC. Enter the increases to the capital account: D. Write: Add: Investments by Owner – 1st amount columnE. Next line, write indented Net Income (line up with

Investments by Owner), ruled and write total amount in 2nd amount column, rule the amount in the 1st column

F. Write Total Increase in Capital below the increases and write the amount in the 2nd amount column, rule it

The Statement of Changes in Owner’s EquityG. Write Subtotal on the next line • Add the beginning capital amount and total increases in capital• Write that amount in the 2nd amount column under the total

increases in capitalH. List the decreases to the capital account beginning on the

next line• Withdrawals• Net loss• Label and enter the withdrawal amounts to the 2nd amount

column and ruleI. On the next line, write Ending Capital, followed by a comma

and the last day of the periodJ. Subtract the withdrawals amount from the subtotal to get

the ending balance of the capital account. Double rule

The Statement of Changes in Owner’s Equity

The Statement of Changes in Owner’s Equity• For a current business, the capital account balance on the

work sheet may not reflect the balance at the beginning of the period

• Where to look to find the current owner’s capital account balance• The General Ledger• Subtract additional investments from the balance shown on the

work sheet

The Statement of Changes in Owner’s Equity: Net Loss• Why is net loss added to owner’s withdrawals?• Both decrease the OE.

• What increased and decreased owner’s equity?• Owner’s investment, increase; owner’s wd and net loss, decrease

Did you know?• The restaurant industry is a key part of the of the US economy• Employs more than 11 million people• Restaurants take in revenues of about $400B a year

The Statement of Changes in Owner’s Equity• How would you express information on the statement of

changes in owner’s equity as an equation?• Beginning capital + Investments + Net Income – Withdrawals =

Ending Capital

• What does this statement mean to you?“The statement of changes in OE shows whether revenue or

additional owner’s investment caused the increase”• Shows specifically where the increase/decrease come from• Whether the increase is due to revenue or addt’l owner

investment

Exit Ticket• What is in the heading of a statement of Owner’s Equity?• What are the sources of information used to prepare the

statement of changes in owner’s equity?• Where can you find the owner’s capital balance at the

beginning of the period?• What elements cause increases to the capital account?• What elements cause decreases to the capital account?

To Do• 9.2: Text p. 229, Wbk p. 164• 9.5: Text p. 242, Wbk p. 166 - 167

What do you think?

• What decisions would you make if you had information showing how much money you spent last month? • Whether you are spending too much• Whether you need to save• How you can pay for something you want but do not have

enough money in a given month

Chapter 9.3 Objectives• How to prepare a balance sheet• The purpose of a statement of cash flows• How to perform ratio analysis

The Balance Sheet• A report of the balances in the permanent accounts at the end

of the period• Snapshot or photo of the business at a specific point in time• Reports the assets and the claims against those assets on a

specific date• It summarizes• What a business owns• What a business owes• What a business is worth

• Prepared from the information in• Balance Sheet section of the work sheet • The statement of owner’s equity

• AKA statement of financial position

The Balance Sheet• Sections of the Balance Sheet• Heading • Assets Section• Liabilities and Owner’s Equity Sections

The Balance Sheet• Heading• Standard Three Line• Name of the Business – WHO• Name of the Financial Statement – WHAT• Date of the Balance Sheet - WHEN

The Balance Sheet• Balance Sheet is listed in report form, listing the balance

sheet sections under one anotherAssetsA. Write Assets on the first line centered in the column for

account namesB. On the following lines, list the asset accounts in the order

they appear on the BS section of the work sheet and their balances (in the first amount column)• Single rule under the last account balance

C. Indented and write Total Assets and then indicate the calculated total in the second amount column

**Do not double rule until you have the Liabilites & OE sections done**

The Balance Sheet

Liabilities & Owner’s EquityD. On the line after Total Assets, write the heading Liabilities

centered E. On the following lines, list the liability accounts, in order, as

they’re listed on the BS sections of the work sheet and their balances (in the first amount column) • Single rule under the last balance

F. Indented, write Total Liabilities, on the line under the last liability account and enter the balance in the second amount column

The Balance Sheet

Owner’s EquityG. On the line under Total Liabilities center and write Owner’s

EquityH. On the next line, write the name of the capital account and

in the second amount column, enter the ending balance (as shown on the statement of owner’s equity)

The Balance Sheet

The Balance Sheet

The Balance Sheet

Proving Assets = Liabilities + Owner’s Equity• Draw a single rule under the balance of the capital account• On the next line, indented, write Total Liabilities and Owner’s

Equity• Then add Total Liabilities and Owner’s Equity• This total must equal the Total Assets• Check the balances, if they match, move ahead! If not, go back

and find and correct the error• Lastly, after A = L + OE, double rule under the Total Assets

amount, and double rule under the Total Liabilities & OE amount

Statement of Cash Flows• What questions would a statement of cash flows answer

about the business?• Cash balance + or – • What was source of cash that came into the business• Where did paid out cash go• Did any area have an unusually high or low amount of cash inflow

or outflow

Statement of Cash Flows• Covers one accounting period • Summarizes• Amount of cash the business took in• Sources of cash• Amount of cash the business paid out• Uses of cash

Statement of Cash Flows• Ratio Analysis

AKA percentage analysis• The process of evaluating the relationship between various

amounts in the financial statements

• Used by owners/managers to determine financial strength, activity, and debt-paying ability of a business

Statement of Cash Flows• Profitability Ratios• Used to evaluate the earnings performance of the business

during the accounting period• Earning power measures company ability to grow and earn revenue

Statement of Cash Flows• Return on Sales• Commonly used profitability ratio• Used to examine the portion of each sales dollar that represents

the profit

TO CALCULATE:• Divide Net Income by Sales

For Example:RoadRunner Delivery Service Net Income = $1,150RoadRunner Sales (Revenue on work sheet)= $2,650

1150/2650 = 0.434 = 43.4% Return on Sales• So, for every dollar of sales, RoadRunner earns 43.4 cents

Statement of Cash Flows• For 2014, net income for RoadRunner increases to $2,750 and

Sales increases to $5,000• What is the return on sales for 2014?• What is the increase over 2013?

• 2750/5000 = 0.550 or 55.0%• 55.0 – 43.4 = 11.6 cent increase over 2013

Statement of Cash Flows• Liquidity Measures• Liquid – an asset that can easily be converted to cash

• Current Assets are those used up or converted to cash during the normal operating cycle of the business• A/R• Cash in Bank• Supplies

• Current Liabilities are debts of the business that must be paid within the next accounting period• A/P

Statement of Cash Flows• Working Capital is the amount by which current assets

exceeds current liabilities• Current liabilities are paid out of current assets, working capital

tells us the assets left over to continue operations• Can find these numbers on the balance sheet

For example, RoadRunner Working Capital • Current Assets = $22,575• Current Liabilities = $11,725• CA – CL = Working Capital• $22,575 - $11,725 = $10,850

Statement of Cash Flows• Liquidity Ratio• Current Ratio & Quick Ratio • Measure of the ability of the business to pay its current debts as

are due• Provide for an unexpected need of cash

Statement of Cash Flows• Current Ratio • Relationship between current assets and current liabilities• Divide current assets by current liabilities (taken from BS)

• Current Liabilities must be paid within a year

RoadRunner Current Ratio: $22,575/$11,725 = 1.92 or 1.9:1

***A ratio of 2:1 or higher is favorable by creditors• This shows a business can pay its debts and has double the

current assets. • A low ratio says a company may have trouble paying its debts

Statement of Cash Flows• Quick Ratio• Measure of the relationship between short-term assets and current

liabilities• Short-Term Liquid Assets – those that can be quickly converted to cash: cash

& net receivables• Divide total cash and receivables by current liabilities

RoadRunner Quick Ratio$22,575/$11,725 = 1.92:1

• Sometimes Current & Quick Ratios are the same• 1:1 for a Quick Ratio is adequate• Says a business can pay its current debts with cash from incoming

receivables• 1:1 or > means a business has a $1.00 in liquid assets for each $1.00

of current liabilities

Statement of Cash Flows• Widget Wonders has a Quick Ratio of 0.78:1• Is this news good or bad? Explain?

• Bad news. Widget Wonders has more liabilities than liquid assets to pay.

Exit Ticket• Compare/Contrast the heading of an income statement and

balance sheet.• To what visual item is a balance sheet often compared?• What is the importance of the Statement of Cash Flows?• What are current assets?• What is working capital?

To-Do• 9.3: Text p. 237, Wbk p. 164• 9.5: Text p. 242, Wbk p. 166 – 167

• Recycle Problem

• 9.6: Text p. 242, Wbk p. 168 – 169• Appendix Ch 9: Text p. A-56, Wbk p.

• Group Project on Ratio Analysis