Preparing the Financial Statements (Financial Accounting Tutorial #25) SPEAKER: In the previous presentation, we created the suggested trial balance. And we listed all the different accounts of the company with their debit and credit balances, working through assets and liabilities and equity accounts, revenues, and expenses. So we listed all of the company's accounts. And you're wondering what are we going to do with all these different accounts? Well, we're going to be moving onto the second last step of this accounting cycle, which is preparing financial statements, which are going to give us a readable and understandable view of the company as a snapshot or a picture to see how they're doing. So why would we need financial statements? Well, let's say this is Ninja Dave over here. And he's a user of financial information. Let's say he's an investor. And he wants to invest in a company. Maybe he wants to invest in Apple, maybe Nike, maybe a completely separate public company. And I don't have financial information, let's say. Let's say I don't have any financial statements to work with. How am I going to invest? Am I going to just look at the graph of one of these different companies and see that it's going up? And oh, yeah, this is a great time. I should invest right here. Oh, no. God, no. And then maybe it's oversold. Maybe I should invest now. Who knows? It's really unpredictable with actually analyzing the financials, which is why we need financial statements. So we're going to be going over the different types of financial statements. Because in order to actually analyze and deconstruct these financial statements, you're going to have to learn how to actually construct them. So we're going to be going over in a sequential order, of course, through three different financial statements. And we're going to see why we're going in sequential order because you have to always follow this order to prepare them. And we're going to start off with the first one being the income statement. And the income statement, of course, is our first statement. And it gives us an idea of the performance. We got our Dave's Music Emporium, which is my company, I guess you can say. And we have an income statement year ended December 31, 2012. Because that's the end of our fiscal period. And the income statement gives us an idea of how we're doing as a company for the year because it gives us an idea of the performance because we have revenues. We have expenses. And we have profits or net income. And the way I constructed this was just by taking these accounts right here. We have our revenues and our expenses. So we've just transposed all of these accounts and created this financial steam. And we've brought over revenue, $2,610, which is right there. Over here, we've lined up our expenses, listed them all underneath. We summarize total expenses. Remember to always put a line underneath revenue expenses, total expenses, and to double underline the final number, which is our net income. And you've got to remember that term because that is not an account within our adjusted trial balance. So net income gives you an idea of how they've basically done, how they've basically done for the year. And as you can see, we have net income or a net loss in brackets. And because we have it in brackets, this is a net loss. So we have not performed well for this fiscal year at all. So now that we have the net loss for our company, we can actually carry this number over and work on our second financial statement, which is going to be retained earnings. Because we need that net income number in order to prepare this statement, which is why I said they always go in order. So we have the retained earnings statement, which uses the balance of January 1, 2012, or the beginning of the year. And basically, what the statement gives us is it gives us an idea of all of the earnings that we have retained or accumulated since the inception of the company, which means the beginning of the company. And we just continuously add each year's net income or the net loss. And this will give us a new retained earnings number. So as you can see, I've just added the net income or the net loss. And of course, we're going to subtract a loss, which is going to give us a amount, which is a retained earnings amount, which is negative, which is actually going to be called something which is known as a deficit. Because if retained earnings is negative, it's going to be called a deficit. And the point of the retained earnings statement is just to look at the accumulated earnings and seeing if we've paid out any earnings to shareholders because what I haven't added in this example is I haven't said that we've subtracted any dividends. Because this is also what you can include in a retained earnings statement if you look at one of a company because dividends are an outflow of earnings from a company. So that's our retained earnings statement. And of course, the reason why this is the second statement is because we needed that net income figure. And the final one is going to be the balance sheet. Well, the third one we're going to cover. There's actually four or five financial statements. But we're only going to be covering three in this tutorial. Don't want to make it too long. And what we're going to start off with is, of course, assets, which is our first part of our balance sheet. And we're going to just transfer all of those different assets, which I have right-- let me just create a new layer-- which we have right on this left side. So these are all assets. Of course, this one is a contra asset. But it still goes in the assets section. And I've listed them all here. As you can see, our total assets are $606,900. And what this basically shows us the balance sheet is that it gives us an idea of the financial position of the company so like what assets do we have. And of course, it's going to show us our liabilities, which show us any debts that we have outstanding like accounts payable or notes payable listed right here, any revenue that we're going to earn in the future, some salaries that we're going to pay soon. And if I move it up even further, you're going to see the equity part. Let me actually get rid of this for a second over here on the left side. I'm just going to-- can't remember which layer I created all this stuff on. There we go. And I'm just going to shrink this down so that you can see the equity portion. Hopefully you can still see everything. We got HD 1080p. So you should be able to see everything. And like I said, we have the equity portion, of course, which includes retained earnings. Because retained earnings is an equity account. And remember that we came up with this retained earnings figure from the retained earnings statement, which is why we had to create the retained earnings statement before creating this balance sheet. And basically, using this balance sheet, we can really analyze a lot of the different figures, look at their assets, liabilities, equity. We can come up with some ratios, maybe like the current ratio, which basically gives us an idea of how many current assets we have to current liabilities. There's many different ratios we can come up with. So basically, learning how to actually create and transfer all these accounts right over here from our adjusted trial balance like these assets and then these liabilities and then our retained earnings from the previous statement, you can construct your balance sheet and really analyze each of these different accounts separately. And that way, we can actually have an understanding of maybe investing in a company. Because with this information, we'll actually have a chance with-- I'm just trying to create a layer so I can draw something. Because with this information, we're going to actually have a chance at possibly realizing benefits from our stock and actually predicting a good choice. So basically, I think that's all I wanted to cover. We're going to be covering the cash flow statement separately since that is a more complicated statement. Hopefully, you understood the general idea of these different statements. And I hope you look at some of the financial statements of different public companies to get an idea. I'll see you guys in the next presentation. We're going to be talking about closing entries. If you have any questions regarding accounting or any of the material within our videos, you can tweet us at @notepirate. 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