This week, let’s review what we learned about these reports from Acme Combustion’s 2008 year-end report. First of all, the Income Statement:
1. The basic form is (Revenue – Expenses) = Net Income.
2. Some expenses, such as depreciation, are not cash. Some expenses, such as cost of goods sold, may not be actual expenses for the period reported. Those costs are the values accrued against the actual goods sold.
3. Owner’s withdrawals (dividends) are not operating expenses but are distributions from net income.
4. Profit is how cash is internally generated to pay for new plant and equipment and to reward the investors. Profit is a necessary cost of continuing to do business.
Now let’s review what we found on the Balance Sheet:
1. The basic form is Assets = (Liabilities + Owners Equity).
2. Assets are the investments made to operate the business, such as building, machinery and inventory. Liabilities and owner equity is how those assets are financed.
3. The Balance Sheet summarizes the financial position at a given time, such as month end or year end.
4. Every transaction is an exchange. Every liability must be offset with an asset for the company to be an ongoing operation.
5. Only transactions measurable in dollars are recorded.
6. Profits increase owner equity, and cash withdrawals by the owner decrease equity.
Next week we will look at the calculation that is the most important element in determining the health of the organization – cash flow.