Accounting concepts are a set of standards that businesses use to record financial transactions. These concepts are universally accepted and help prevent disputes, discrepancies and claims of fraud or mismanagement.
The historical cost concept states that assets and liabilities should be recorded at their historic cost rather than their current market value. This is to ensure that the information included in the books of accounts is reliable and verifiable.
A balance sheet is a financial statement that provides a snapshot of a business’s finances (what it owns and owes) at a specific point in time. Whether you are reviewing the balance sheet for your own company or as a potential investor, it is an important financial tool.
A company’s balance sheet will follow an accounting equation, where assets are on one side and liabilities and shareholder equity are on the other, with both sides balancing out. This equation makes sense because a company has to pay for everything it owns by either borrowing money as a service (liabilities) or taking it from investors (issuing shareholder equity).
Assets include cash and cash equivalents, short-term government bonds, accounts receivable, inventory and other items that can be converted into cash quickly. Non-current assets include plant, property and other long-term investments that cannot be converted to cash quickly, but that will last more than a year. Liabilities include a company’s current debt and long-term debt, which may include interest payments on loans or obligations to pay for goods and services in the future.
Profit and loss statement
The profit and loss statement, also known as an income statement or P&L report, is a financial document that details a company’s revenues and expenses over a specific period. It is usually prepared monthly, quarterly or annually and helps business owners understand how their businesses are doing.
A P&L statement starts with the revenue section, which shows total sales for a period of time. It also includes lines for cost of goods sold, gross margin and selling and administrative expenses.
When a company sells merchandise, it may have to pay sales discounts and allowances, which will be shown in the net revenue line. When these deductions are taken out, the company’s net revenue is the total amount of money it expects to make during an accounting period.
The next line in the P&L statement is the costs of sales, which includes all the expenses incurred in producing a product or service. The costs are subtracted from the net revenue to produce a number called net income or profit.
Cash flow statement
The cash flow statement is an important component of a company’s financial statements. It provides a comprehensive view of a firm’s cash movement over a period of time, and it works in tandem with the income statement and balance sheet to provide a complete picture of a company’s financial health.
Cash inflows from operations include cash received from the sale of goods and services, royalties on the use of a company’s assets, or other sources of cash. It also includes money paid to suppliers for raw materials or equipment.
Free cash flow (FCF) is the cash you have on hand before paying off any debt or investing in new capital. This is calculated by subtracting noncash expenses, interest payments, and changes in working capital from net income.
Adjusting for current liabilities (accounts receivable, inventories, and prepaid expenses) is an important part of the cash flow statement. The more money you owe to your customers, the less cash you have available.
Statement of cash flows
The cash flow statement shows how much money a company receives and spends over time. This allows companies to assess their liquidity and long-term solvency.
The statement is divided into three principal segments: cash from operating activities, cash from investing, and cash from financing. The cash from operations section displays cash inflows and outflows that are primarily generated through operating business activities, such as sales of products or services, inventory transactions, interest payments, tax payments, and wages to employees.
Cash from investing includes money that a company spends on investments such as buying equipment, building buildings or purchasing short-term assets. An increase in investment activity on the cash flow statement is a sign that a company is investing in its future.
The last section of a cash flow statement is the cash flow from financing. This section measures cash flows from a company’s owners and creditors, usually through debt or equity. These figures are typically reported on a company’s 10-K report to shareholders each year.