"Financial Statements: Statement of Financial Position and Income Statement"
A taco shop in Guadalajara asks the bank for a loan to open a second location. The first thing the bank asks for is the statement of financial position and the income statement. Why? Because with those two documents, the bank knows what the company has, what it owes, and how much it really earns. And watch out: a company can show profits and still not have the money to pay its payroll. By the end of this page we will see why.
Equity and Its Three Components
Why it always holds: everything the company has was paid for with money that came from someone, either from third parties (liabilities) or from the owners (shareholders' equity).
Define a company's equity and liabilities structure, and explain in your own words what its three balance sheet categories represent: assets, equity, and liabilities.
Define a company's equity and liabilities structure, and explain in your own words what its three balance sheet categories represent: assets, equity, and liabilities.
Classify these balance sheet items as assets, equity, or liabilities: a van, a five-year bank loan, warehouse merchandise, capital contributed by partners, office…
Classify these balance sheet items as assets, equity, or liabilities: a van, a five-year bank loan, warehouse merchandise, capital contributed by partners, office computers, and a debt to a supplier.
The Statement of Financial Position
The statement of financial position (also called the balance sheet) is a snapshot of the company on a given date: it shows assets on the left and liabilities and shareholders' equity on the right.
To see whether a company can pay its immediate debts, we use working capital: current assets minus short-term liabilities. In the example: $30,000 - 15,000 = \$15,000$.
The figure shows the balance sheet structure with its two columns. Identify the missing balance sheet category, marked with "?", explain what it represents, and write…
The figure shows the balance sheet structure with its two columns. Identify the missing balance sheet category, marked with "?", explain what it represents, and write the fundamental accounting equation that relates the three categories.
A company has total assets of $\$3\,000\,000$ and liabilities of $\$1\,800\,000$. a) Calculate its equity. b) Interpret the result and explain what negative equity (a…
A company has total assets of $\$3\,000\,000$ and liabilities of $\$1\,800\,000$. a) Calculate its equity. b) Interpret the result and explain what negative equity (a situation of technical insolvency) would mean instead.
The Income Statement Step by Step
While the statement of financial position is a snapshot, the income statement is a movie: it shows what happened during a period (a month, a year).
Revenue is not collection, expense is not payment
Financial statements follow the accrual principle: revenue is recorded when the sale is made, even if the customer pays later; an expense is recorded when it is incurred, even if it is paid later. Example: an academy teaches a course in March and gets paid in April. The revenue belongs to March; the collection, to April. Likewise, if it receives the March electricity bill and pays it in April, the expense belongs to March and the payment to April.
An academy billed $\$1\,600\,000$ for courses and incurred expenses of $\$1\,300\,000$ (salaries, rent, utilities, and advertising). a) Calculate the profit for the…
An academy billed $\$1\,600\,000$ for courses and incurred expenses of $\$1\,300\,000$ (salaries, rent, utilities, and advertising). a) Calculate the profit for the financial year. b) Explain the difference between revenue and cash receipt, and between expense and cash payment, using an example from the academy.
At the close of its first year, a public limited company presents the following pre-adjustment accounting balances: Sales of merchandise $\$120,000…
At the close of its first year, a public limited company presents the following pre-adjustment accounting balances: Sales of merchandise $\$120,000$, Commercial premises $\$90,000$ (non-depreciable land accounts for $30\ \%$ of its value), Final inventory of merchandise $\$20,000$, Long-term debts with credit institutions $\$30,000$, Suppliers $\$10,000$, Wages and salaries $\$45,000$, Share capital $\$50,000$, Purchases of merchandise $\$30,000$, Computer equipment $\$10,000$, and Other operating expenses $\$15,000$. The accountant forgot to record the annual depreciation of the premises ($2\ \%$) and the computer equipment ($20\ \%$), as well as the accrual of corporate income tax ($25\ \%$). a) Prepare the adjusted income statement, calculating the profit before tax and the profit for the year after correcting the accounting omissions. b) Prepare the final balance sheet grouped by accounting categories, calculating the cash balance required to balance the balance sheet and incorporating the profit obtained. c) Interpret the meaning of the resulting equity and determine whether the company has generated real self-financing capacity.
Depreciation: An Expense With No Payment
Financial Statements and Useful Information
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Statement of financial position: what the company has, owes, and is worth on a given date.
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Income statement: whether it earned or lost money during a period.
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Cash flow: where the money came in from and where it went out to.
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Notes to the financial statements: explain the accounting criteria used (for example, how assets are depreciated), detail important accounts such as debts and contingencies, and clarify relevant facts that the figures alone do not show.
Why does the law require them to be prepared? Because a company, especially a corporation such as an S.A. de C.V., handles money from partners, banks, and suppliers, and all of them need reliable information to make decisions. That is why commercial corporations must keep accounting records and prepare their financial statements each fiscal year; they must keep them and, depending on their type, present them to their partners and to the authorities. The Public Registry of Commerce gives publicity to the acts and data of corporations, so that third parties (someone who is going to sell to them on credit, for example) can look up information about them.
Who uses them? Banks to grant credit, suppliers to sell on payment terms, investors to make decisions, and the SAT (the tax authority) to verify that the correct ISR is paid. Legal entities must file annual returns. Manipulating the figures (inflating sales or hiding debts) deceives third parties and can lead to fines, tax crimes, loss of credit, and liability for the managers. That is why the NIF require useful and reliable information that reflects the company's real situation.
The annual accounts include the balance sheet, the profit and loss account, and the notes to the accounts. Explain what information each document provides and why the…
The annual accounts include the balance sheet, the profit and loss account, and the notes to the accounts. Explain what information each document provides and why the law obliges companies to prepare them and file them at the Companies House / Commercial Registry.
The management team of an industrial company experiencing financial difficulties is debating two proposals before closing the financial year to avoid showing losses: 1)…
The management team of an industrial company experiencing financial difficulties is debating two proposals before closing the financial year to avoid showing losses: 1) not to record the annual depreciation of machinery ($\$35,000$) under the pretext that "it has been stopped for several months and has not worn out", and 2) to fully recognize as income for the year an advance payment of $\$80,000$ made by a customer on account of an order that will be manufactured and delivered next year. a) Rebut both proposals by identifying which mandatory accounting principles and which aspects of the "true and fair view" principle would be violated in each case. b) Reasonably predict the equity, financial, and legal consequences this creative accounting would have for suppliers who decide to grant trade credit to the company based on these accounts, and for the directors who prepare them.
Income Is Not Cash in the Bank
Let's go back to the question at the beginning. A trading company closes December reporting income of $\$45,000$, but on January 5 it has only $\$2,000$ in the bank.
A computer equipment trading company closed the month of December with a net profit of $\$45,000$. However, on January 5, its current account balance is only $\$2,000$…
A computer equipment trading company closed the month of December with a net profit of $\$45,000$. However, on January 5, its current account balance is only $\$2,000$ and it must face the payment of payroll ($\$22,000$), social security contributions ($\$7,000$), and the maturity of a bank loan installment ($\$18,000$). Its usual commercial policy consists of granting its customers 90-day payment terms, while paying its suppliers in cash; in addition, in December it purchased a delivery van in cash for $\$35,000$. a) Technically justify why a profitable company can find itself at imminent risk of insolvency/suspension of payments, identifying the specific transactions that have caused this liquidity squeeze. b) Design an immediate action plan to face that week's payments without resorting to staff layoffs, and propose two structural measures for managing the operating cycle to prevent the situation from recurring.