It is important to note that without people, there will be no business and without businesses, there is no need for accounting. Accountants capture raw data gathered from business ventures, translate it into meaningful information for the management to use in decision making.
The financial statement is for external usage because it tells individuals, other businesses, creditors, financial institutions, and the IRS about the health of your business. Consider the financial statement to be likened to your medical report which explains everything about your medical history. The financial statement also explains how to sick the company is, the amount of debt owed, loan payments made, any outstanding loans, profit or losses incurred, etc.
To understand the financial statement, which is the end-product, you need to grasp these fundamental principles:
- Tip 1: Go back and revise the primary books (first, original, initial) entry if you have forgotten. The books are:
- the Journal (it captures every information or transactions that take place in the business daily; it is like a camera that takes pictures relating to business dealings);
- the “T” account, which is in the form of letter “T”. This account is often referred to as the schematic account. It summarizes the information from the journal per account type to get the required balances. You must open one “T” account per account type (e.g. cash, office supplies, accounts payable, etc.);
- and, finally, the Trial balance, which tests, or “trials”, all the balances from the “T” account to see if the Debit is equal to the Credit. If it balances, you are now ready to prepare the financial statement.
- Tip 2: Read and understand every item and the keywords. All information is relevant. Try to understand it first before deciding to use it or not per the problem at hand. Whether you are dealing with the Income Statement, Statement of Owner Equity, Balance Sheet, or Cash Flow the principle is the same only the items and method of presentation that differs.
- Tip 3: Do not guess (you might be committing fraud or “cooking the books”, which is punishable by law). If you are not sure, please consult the Generally Accepted Accounting Principle (GAAP) for help and clarity.
- Tip 4: You need to know the specific items to put in each statement, which means you must be able to define the statement and understand its importance, usage/usability or when it is applicable.
- Tip 5: Pay detail attention as you carry your assignment because one mistake can be very expensive for the company to cover the cost of correction.
If you understand these tips, I believe that you will be able to handle issues of financial statement analysis. I wish you all the best in your endeavors.
Edmond Lyonga is a former Academic Skills Center Peer Tutor in Accounting and Finance.