Virtual Business: Retailing
Lesson 15
Financial Statements
• Business owners must have accurate & timely
information about the financial status of their
business to make the best decisions
• Most of this financial information is derived
from financial statements
• Well-prepared financial statements can
provide a guide for getting the business
started & for keeping it on a successful path
• After completing this lesson you will be able to:
– Define the components of an income statement
– Identify the line items that make up a balance sheet
– Explain how financial statements can be used to
evaluate past business & predict future performance
– Calculate equity based on assets & liabilities
– Compute revenue, net sales, gross margin, & net
profit
– Identify different businesses based on financial
statements
What are Financial Statements?
• Financial statements are reports that give a
detailed pictures of a business’s financial status
for a given period of time
• Financial statements detail changes in a
business’s financial status
• Study of financial statements can tell a business
owner whether the business is on a successful
path or if there are financial troubles ahead
• Two of the most common financial statements
are the income statement & the balance sheet
• The Income Statement
– A report that outlines projected business revenue &
projected business expenses for a given period of time
• Revenue is the money collected for products sold by a
business
• The difference bet. revenue & expenses is the business’s
profit
– This statement, also known as the P & L (profit & loss),
is the most frequently used financial statement
• It is your main “scorecard” for projecting profit or loss for a
specified period of time—a month, 3 months, or a year
• When business owners refer to the “bottom
line,” they’re talking about the bottom line of
the income statement: profit
– Profit is the $ made by a business once costs &
expenses have been deducted from the revenue
– The information contained in an income
statement will tell a business owner how well
his/her business is doing
• There are many components of an income statement:
– Gross sales:
• This figure for a new business will be an estimate of
sales for the time period
• For an established business, this is the amount of $
made from selling store merchandise
– Net sales: [Sales – Returns & Discounts]
• The amount of $ in sales after returns & discounts are
subtracted
• Cost of goods sold [COGS}:
– The amount of $ spent to buy the merchandise
that is sold
• Gross margin:
– The amount of $ that remains from net sales less
the cost of goods sold [Net Sales – COGS]
– This is the amount of $ that will be used to pay
the business’s expenses for the period & then
deliver the business’s profit or loss
• Operating expenses:
– All of the expenses associated with running (operating) the
business
• Income: [Gross Margin – Operating Expenses]
– The amount of $ left after subtracting the operating expenses
from the gross margin
• Taxes:
– The amount of $ owed to federal, state,& local governments
– The estimated amount of taxes is deducted from income
• Net income: [Income – Taxes]
– The amount of $ left after taxes are deducted
– Profit means that the business gained $ during the time period
– Loss means that the business lost $ during the time period
• The Balance Sheet [Assets = Liabilities + Owner’s Equity]
– A report that summarizes the business’s assets &
liabilities & the owner’s equity
• Assets are tangible items of value owned by a business, such
as a store’s inventory or cash
• Liabilities are debts that a business has, such as loans,
wages, or taxes owed
• The difference bet. assets & liabilities is called equity
Equity = Assets - Liabilities
– The purpose of a balance sheet is to show a clear
picture of the business’s assets & liabilities
• It provides a snapshot of assets & liabilities for the point in
time at which it is prepared
Analysis of Past Performance
• It is important to carefully analyze the
information provided in financial statements
• Analysis will help to determine patterns or
trends
• The information can also reveal areas of
potential concern before they become major
problems
• Analysis of past business performance can
help with planning for a successful future
• Predicting Future Performance
– Financial statements can be effective tools to help
plan the future of a business
• For instance: if your business records show a pattern of
sales that increase significantly during the summer
months, you can then arrange to purchase additional
inventory for those months, you can then arrange to
purchase additional inventory for those months
• Doing so will ensure that there is enough merchandise
on the sales floor for maximum revenue during that
prime period
• Financial statements often prepared based on
projections or estimates of future events, such
as sales or purchases, are referred to as pro
forma financial statements
– Pro forma is a Latin term that means “according to
form”
– Pro forma financial statements are used in
business plans when the business being proposed
has not yet been started
• Business Plans & Financial Statements
– A business plan is a map or blueprint for starting a
new business
– As we will learn in the unit on business plans,
financial information is a major part of a business
plan
– A business plan requires financial information that
includes projected income & expenses, projected
cash flow, & a projected balance sheet for the 1st
business year
Key Math Concepts
• Compute Revenue
To compute revenue, use this formula:
Revenue = Unit Sales x Average Price per Unit
• Compute Net Sales
Net sales are a part of the income section of
an income statement
To compute net sales, use this formula:
Net Sales = Total Sales – Returns & Discounts
• Compute Gross Margin
To compute gross margin from sales, use this
formula:
Gross Margin from Sales =
Net Sales – Cost of Goods Sold
• Compute Net Profit
To compute net profit, use this formula:
Net Profit = Total Revenue – Total Expenses
• Compute Equity on a Balance Sheet
To compute equity on a balance sheet, use
this formula:
Equity = Assets - Liabilities
Summary
• In this unit we have looked at the purpose &
importance of financial statements to both new &
established businesses
• We specifically examined the information
contained in income statements & balance sheets
• Additionally, we discussed the importance of
analyzing the information provided by financial
statements & how that analysis can be useful
• Lastly, we reviewed some of the math used in
producing financial statements