Understanding Financial Statements

Key Takeaways

• Accountants prepare four financial statements: income statement, statement of owner's equity, balance sheet, and statement of cash flows (which is discussed later in the chapter).
• The income statement shows a firm's revenues and expenses and whether it made a profit.
• The balance sheet shows a firm's assets, liabilities and owner's equity (the amount that its owners have invested in it).
• The balance sheet is based on the accounting equation:
  
  assets = liabilities + owner's equity
  
  This equation highlights the fact that a company's assets came from one of two sources: either from loans (its liabilities) or from investments made by owners (its owner's equity).
• The statement of owner's equity reports the changes in owner's equity that have occurred over a specified period of time.
• Financial statements should be competed in a certain order: income statement, statement of owner's equity, and balance sheet. These financial statements are interrelated because numbers generated on one financial statement appear on other financial statements.
• Breakeven analysis is a technique used to determine the level of sales needed to break even - to operate at a sales level at which you have neither profit nor loss.
• To break even, total sales revenue must exactly equal all your expenses (both variable and fixed costs).
• To calculate the breakeven point in units to be sold, you divide fixed costs by contribution margin per unit (selling price per unit minus variable cost per unit).
• This technique can also be used to determine the level of sales needed to obtain a specified profit.