As we all know accounting is a very important part of any business organization whether it's a profit making organization or non-profit making organization. Sometimes it looks scary. Most of us fear to see the subject of accounting and always say that who the hell made this subject. But the most important fact is, it is the only subject which ultimately tells you how much money is there in your pocket to spend out ... 
So let start with the basics of accounting that always helps when ever you deal with money or financial transactions. Here, we are going to see how parts of the financial statements fit together. First of all we will see what are the financial satatements which are equally important to make a complete understanding of accounting. Here we go...
Let first have a look upon balance sheet. What do we mean by balance sheet? Why do we feel its need? or a question may be, the importance of balance sheet? We will see all these answers one by one.
The balance sheet, the most important account book of any person, any organization, any bank and so on. Balance sheet is the book where we record three very important things, mind it very important.
It tells about financial Position of a company. the first accounting equation is derived from balance sheet given below.
Assets= Liabilities+Shareholders' equity
Balance sheet has two sides as per the above accounting equation. the first one is asset side which tells about application of funds or investment of funds, whereas another one tells about financing sources of funds. This also justify that why should balance sheet have two sides.
Now lets move to Income statement which tells about the profit and loss incurred to a company after selling a product and generating revenue. After cutting all the expenses (operating, financial, and miscellaneous).
Structure of Income statement will be like this:
Net Revenue
- Cost of Goods Sold
=Gross Margin
-Operating Expenses
=EBIT (earning income before taxes)
-Interest Expenses
=Income before taxes
-Inocme taxes
=Income after tax
+Extraordinary Items
=Net income
-Preferred dividends
=Net income available to common
So here, we get net income available to shareholders.
Let's have a look upon cash flow statement which tells about cash inflows and cash outflows. Mostly cash flow is the result of three process as give below:
Cash from opeation employs net income, net cash provided by operating activities, Depreciation and amortization, Tax benefits of employees stock plans, gains/loss on investments, operating working capital and so on.
Cash from investing employs investment in securities: purchase, maturities and sales, capital expenditures and so on
Cash from financing employs purchase of common stocks, issuance of common stocks under employee plans and many more.
And at last, the statement of shareholders' equity which is given by this equation:
Beginning equity + comprehensive income - Net payout to shareholders = Ending equity
This is what we have discussed yet about important statements that makes complete knowledge of basic accounting.
Now lets see how these statement plays an important role. To understand this here I have choosen an easy example named as "Accounting for a saving account"
We all know what is saving account, we all invest even, it is the simplest of investments we do in our life. The first investment many of us made, as children, was in saving account. Some basic features of saving account we learnt, are the concept of simple interest , withdrawals (dividends), and compound interest (which comes from not withdrawing from the account, but rather reinvessting in the account) . Here, we have first to understant the notion of earnings, we earned interest in the account, and the book value is the balance posted in our passbook when soever we went to bank to get the book updated. This book value keep on changing as per the given equation:
book value of the saving account at the end of a qaurter = book value at the beginning of the quarter + earnings for the quarter - Withdrawals + New deposits.
To get going, let's construct a set of financial statements for a saving account. Suppose Rs. 150 is invested in an account earning an interest rate of 10% for one year. the earnings of Rs 20 withdrawan at the end of the year, leaving Rs. 145 in the account. The four statements tell the story of this investment for the year:
Balance sheet:
Assets Rs 150
Owners' equity Rs 150
Income Statement
Revenue Rs 15
Espenses Rs 0.00
Earnings Rs. 15
Statement of Cash Flows
Cash from operations Rs 15
Cash from investing Rs 0
Cash in financing activities:
Withdrawal Rs (20)
Change in cash Rs (5)
Statement of Owners' equity
Balance, beginning of the year Rs 150
Withdrawals Rs (20)
Earnings Rs 15)
Balance, at the end of the year Rs 145
You can also see this story is in terms of book values, earnings, cash flows, and dividends.
So let start with the basics of accounting that always helps when ever you deal with money or financial transactions. Here, we are going to see how parts of the financial statements fit together. First of all we will see what are the financial satatements which are equally important to make a complete understanding of accounting. Here we go...
- Balance sheet
- The Income Statement
- Cash flow statement
- statement of shareholder's equity
Let first have a look upon balance sheet. What do we mean by balance sheet? Why do we feel its need? or a question may be, the importance of balance sheet? We will see all these answers one by one.
The balance sheet, the most important account book of any person, any organization, any bank and so on. Balance sheet is the book where we record three very important things, mind it very important.
- Assets
- Liabilities
- Shareholders' equity
It tells about financial Position of a company. the first accounting equation is derived from balance sheet given below.
Assets= Liabilities+Shareholders' equity
Balance sheet has two sides as per the above accounting equation. the first one is asset side which tells about application of funds or investment of funds, whereas another one tells about financing sources of funds. This also justify that why should balance sheet have two sides.
Now lets move to Income statement which tells about the profit and loss incurred to a company after selling a product and generating revenue. After cutting all the expenses (operating, financial, and miscellaneous).
Structure of Income statement will be like this:
Net Revenue
- Cost of Goods Sold
=Gross Margin
-Operating Expenses
=EBIT (earning income before taxes)
-Interest Expenses
=Income before taxes
-Inocme taxes
=Income after tax
+Extraordinary Items
=Net income
-Preferred dividends
=Net income available to common
So here, we get net income available to shareholders.
Let's have a look upon cash flow statement which tells about cash inflows and cash outflows. Mostly cash flow is the result of three process as give below:
- Cash from operations
- Cash from investing
- Cash from financing
Cash from opeation employs net income, net cash provided by operating activities, Depreciation and amortization, Tax benefits of employees stock plans, gains/loss on investments, operating working capital and so on.
Cash from investing employs investment in securities: purchase, maturities and sales, capital expenditures and so on
Cash from financing employs purchase of common stocks, issuance of common stocks under employee plans and many more.
And at last, the statement of shareholders' equity which is given by this equation:
Beginning equity + comprehensive income - Net payout to shareholders = Ending equity
This is what we have discussed yet about important statements that makes complete knowledge of basic accounting.
Now lets see how these statement plays an important role. To understand this here I have choosen an easy example named as "Accounting for a saving account"
We all know what is saving account, we all invest even, it is the simplest of investments we do in our life. The first investment many of us made, as children, was in saving account. Some basic features of saving account we learnt, are the concept of simple interest , withdrawals (dividends), and compound interest (which comes from not withdrawing from the account, but rather reinvessting in the account) . Here, we have first to understant the notion of earnings, we earned interest in the account, and the book value is the balance posted in our passbook when soever we went to bank to get the book updated. This book value keep on changing as per the given equation:
book value of the saving account at the end of a qaurter = book value at the beginning of the quarter + earnings for the quarter - Withdrawals + New deposits.
To get going, let's construct a set of financial statements for a saving account. Suppose Rs. 150 is invested in an account earning an interest rate of 10% for one year. the earnings of Rs 20 withdrawan at the end of the year, leaving Rs. 145 in the account. The four statements tell the story of this investment for the year:
Balance sheet:
Assets Rs 150
Owners' equity Rs 150
Income Statement
Revenue Rs 15
Espenses Rs 0.00
Earnings Rs. 15
Statement of Cash Flows
Cash from operations Rs 15
Cash from investing Rs 0
Cash in financing activities:
Withdrawal Rs (20)
Change in cash Rs (5)
Statement of Owners' equity
Balance, beginning of the year Rs 150
Withdrawals Rs (20)
Earnings Rs 15)
Balance, at the end of the year Rs 145
You can also see this story is in terms of book values, earnings, cash flows, and dividends.