Virtual Business: Retailing

1. Virtual Business: Retailing Lesson 15 Financial Statements

2. 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

3. 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

4. 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

5. 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

6. 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

7. 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

8. 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

9. 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

10. 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 equityEquity = 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

11. 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

12. 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

13. 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

14. 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

15. Key Math Concepts • Compute RevenueTo compute revenue, use this formula:Revenue = Unit Sales x Average Price per Unit • Compute Net SalesNet sales are a part of the income section of an income statementTo compute net sales, use this formula:Net Sales = Total Sales – Returns & Discounts

16. Compute Gross MarginTo compute gross margin from sales, use this formula:Gross Margin from Sales =Net Sales – Cost of Goods Sold • Compute Net ProfitTo compute net profit, use this formula:Net Profit = Total Revenue – Total Expenses

17. Compute Equity on a Balance SheetTo compute equity on a balance sheet, use this formula:Equity = Assets - Liabilities

18. 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