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How Do You Prepare Financial Statements?

How Do You Prepare Financial Statements

Preparing financial statements involves several steps to aggregate and analyze the financial data recorded in a company’s accounting records. The primary financial statements include the Income Statement (Profit and Loss Statement), Balance Sheet, and Cash Flow Statement.

Here’s an overview of how to prepare each financial statement

1. Income Statement

  • Start with the revenue section – Summarize all revenue earned by the company during the accounting period. Include revenue from sales, services rendered, interest income, and any other sources of income.
  • Subtract the cost of goods sold (COGS) – Calculate the direct costs associated with producing or purchasing the goods sold by the company. This yields the gross profit.
  • Deduct operating expenses – Subtract all operating expenses incurred by the company, such as salaries, rent, utilities, marketing expenses, depreciation, and other administrative expenses.
  • Calculate operating income – Subtract total operating expenses from gross profit to determine the operating income (or loss).
  • Consider non-operating items – Include any non-operating income or expenses, such as interest income, gains or losses on investments, and other one-time items.
  • Calculate net income – Add or subtract non-operating items from operating income to arrive at the company’s net income (or net loss) for the period.

2. Balance Sheet

  • List assets – Summarize all assets owned by the company, including current assets (cash, accounts receivable, inventory, etc.) and non-current assets (property, plant, equipment, intangible assets, etc.).
  • List liabilities – Summarize all liabilities owed by the company, including current liabilities (accounts payable, short-term loans, accrued expenses, etc.) and non-current liabilities (long-term debt, deferred tax liabilities, etc.).
  • Calculate equity – Calculate the company’s equity by subtracting total liabilities from total assets. Equity includes contributed capital from shareholders and retained earnings.
  • Ensure the accounting equation balances – Assets must equal liabilities plus equity to ensure the balance sheet balances.

3. Cash Flow Statement

  • Start with operating activities – Summarize cash inflows and outflows from the company’s core operating activities, such as sales receipts, payments to suppliers, and payments to employees.
  • Analyze investing activities – Summarize cash inflows and outflows from investing activities, such as purchases or sales of property, plant, equipment, investments in securities, and other long-term assets.
  • Consider financing activities – Summarize cash inflows and outflows from financing activities, such as proceeds from issuing debt or equity, payments of dividends, and repayment of debt.
  • Calculate net cash flow – Summarize the net increase or decrease in cash and cash equivalents for the period by adding or subtracting cash flows from operating, investing, and financing activities.

After preparing each financial statement, it’s necessary to review and analyze the information to ensure accuracy and reliability. Financial statements provide valuable insights into a company’s financial performance, position, and cash flow, helping stakeholders make informed decisions about the business.