Balance sheet

A company’s balance sheet is a financial statement and gives a picture of its balance between assets and liabilities plus owner’s equity at the end of a particular period, usually the 12-month period of its financial year.

Financial reports – the Profit and Loss account and Balance Sheet are produced from the information in the accounts in the accounting system. Figure shows the process of recording and reporting transactions in an accounting system.

Note: the income statement reports on changers over a period of time and

the Balance Sheet reports financial conditions at a specific point in time.

B usiness is conducted through a series of Business events

w hich are described in financial terms as Transactions

a nd recorded on Source documents

t hat are recorded in an Accounting system

c omprising a series of Accounts

of which there are four types

A ssets Liabilities Income Expenses

which determine the

Capital of the business Profit of the business

which are presented in financial reports

Balance Sheet Profit and Loss account

Reporting profitability

Businesses exist to make a profit. The basic accounting concept is that:

Profit = income – expenses

However, business profitability is determined by the matching principle – matching income earned with the expenses incurred in earning that income. Income is the value of sales of goods or services produced by the business. Expenses are all the costs incurred in buying, making or providing those goods or services and all the marketing and selling, production, logistics, human resource, financing and management costs involved in operating the business.

The profit (or loss) of a business for a financial period is reported in a Profit or Loss account.

The turnover is the business income or sales of goods and services. The cost of sales is either:

• the cost of providing a service

• the cost of buying goods sold by a retailer; or

• the cost of raw materials and production costs for a product manufacturer.

However, not all the goods bought by a retailer or used in production will have been sold in the same period as the sales are made. The matching principle requires that the business adjusts for increases or decreases in inventory – the stock of goods bought or produced for resale but not sold. Therefore, the cost of sales in the accounts is more properly described as the cost of goods sold, not the cost of goods produced. Because the production and sale of services are simultaneous, the cost of services produced always equals the cost of services sold. The distinction between cost of sales and expenses leads to two types of profit being reported: gross profit and operating profit.

Gross profit is the difference between the selling price and the purchase ( or production ) cost of the goods or services sold.

Gross profit = sales – cost of sales

Expenses will include all the other ( selling, administration, finance etc ) costs of the business, that is those not directly concerned with buying, making or providing goods or services, but supporting that activity. The same retailer may treat the rent of the store, salaries of employees, distribution and computer costs and so on as expenses in order to determine the operating profit.

Operating profit = gross profit – expenses

The operating profit is one of the most significant figures because it represents the profit generated from the ordinary operations of the business. It is also called net profit, profit before interest and taxes ( PBIT ) or earnings before interest and taxes. For any particular business, it is important to determine the demarcation between cost of sales and expenses.

From operating profit, a company must pay interest to its lenders, income tax to the government and a dividend to shareholders. The remaining profit is retained by the business as part of its capital.