Financial Reports

Let us now turn to the two most common financial reports. The profit and loss statement or trading statement and the balance sheet. The first type of report is concerned with income and expense accounts. Its purpose is to show how we arrived at our retained earnings (net profit) for a given time frame. Typically this is a one month period, but some organisations may print reports only for the quarter or entire year. The report often comes in several sections which some firms combine together while others print separately. The first part is the revenue/income/trading section. It includes the income accounts and direct expenses. It might take the form of:

Strictly speaking, a trading statement would probably not show an "other income" section in this part of the report since "other income" is not a part of regular day to day trading. This is why some accountants prefer to call this report the income statement.

The gross profit differs from net profit in that indirect expenses have not yet been taken into account. These expenses are listed in the expense schedule portion of the profit and loss statement:

As we can now more clearly see, net profit is calculated by adding up the income account balances (which are conveniently all credits) and deducting the expense accounts (which are all debits).

Previously it was mentioned that net profit and retained earnings are the same thing. In certain circumstances this may not be the case and this is shown in the appropriations section of the profit and loss statement. Appropriations inform readers of the report what was done with the net profit. Shareholders may seek dividends and the taxation department will want their cut. This section might take the form of:

Statement of appropriations

                                                  current

                                                    month

Net profit before tax 64.22

Less income tax expense 19.27

                                             ------------

Net profit after tax 45.95

Less dividends declared/paid 0.00

                                             ------------

Retained earnings for period 45.95

                                             ------------

Although income tax expense is an ordinary expense account, we show this after the other expenses are listed on the report. This is because company tax will be based on your net profit and this must therefore be calculated last. What is left after this is retained earnings. This may receive further deductions in the form of dividends paid to shareholders. If dividends are not issued, the remainder is carried into the balance sheet report and becomes part of the firm's retained earnings.

Observe one other interesting point: tax on earnings is calculated before dividends (if any) are provided to shareholders. Dividends are not usually tax deductible. While they are, in a sense, an expense to the company concerned, they are treated as a special type of non-deductible expense.

The balance sheet report lists your company assets, liabilities and special liabilities that was previously referred to as CAPITAL. Deducting liabilities from assets equals net worth. Net worth should also be equal to retained earnings plus other shareholder or owner investments. This is equivalent to the firm's total equity. That is to say, total equity = net worth. This is the balance sheet up to the calculation of net assets:

The final section of the report lists the CAPITAL accounts:

In this case, retained earnings for the current period ($45.95) as calculated on the profit and loss statement, has been lumped together with retained earnings from prior periods (sometimes referred to as reserves) of $9554.61. The total adds up to $9600.56.

Observe once again the principle total equity = net worth. If a company makes a profit this means a gain in assets. After all, the profit is going to be in the form of cash, or a higher debtor balance or more stock, etc. So an asset must be increased by a certain amount along with the retained earnings account. Likewise, if a loss is made, this increases a liability or reduces an asset (or both) and, of course, retained earnings is also reduced. As you can see from this, asset and liability accounts are linked to CAPITAL liability accounts. A change in one will directly cause a change in the other.