The two main financial statements are the income statement and the statement of financial position. Each contains particular items that must be placed correctly. Understanding these items is essential so that the statements can be read accurately.
Items in the income statement
The income statement works out whether the business made a profit or a loss. Its main items are:
- Sales (revenue) — money earned from selling goods or services.
- Cost of goods sold — the cost of goods that were sold, including opening stock, purchases and closing stock.
- Gross profit — sales minus cost of goods sold.
- Expenses — costs such as salaries, rent, electricity and transport.
- Net profit — gross profit minus expenses.
Key idea
Gross profit = Sales − Cost of goods sold. Net profit = Gross profit − Expenses. Gross profit deducts only the cost of stock, while net profit deducts all operating expenses.
Items in the statement of financial position
This statement shows the position of the business on one date. Its items are classified as follows:
- Non-current assets — long-term assets such as buildings, vehicles and machinery.
- Current assets — short-term assets such as stock, debtors and cash.
- Liabilities — the business's debts, such as creditors and loans.
- Owner's equity — the owner's capital plus profit and minus drawings.
Example
Ms Lily's business records sales of RM90,000 and cost of goods sold of RM55,000, giving a gross profit of RM35,000. After deducting expenses of RM12,000, her net profit is RM23,000. Her delivery van is recorded as a non-current asset.
How the two statements link
The two statements are connected. The net profit worked out in the income statement is carried into owner's equity in the statement of financial position. If the business makes a profit, owner's equity increases; if it makes a loss, equity falls. The basic principle is Assets = Owner's equity + Liabilities, meaning total assets must always equal the combined equity and liabilities. This is why the statement of financial position must "balance".
By identifying these items correctly, a business can prepare accurate statements and meet its reporting needs.