How to Calculate Financial Statements in Accounting

by Craig Woodman

The completion of financial statements for a specific accounting period is eagerly anticipated by most business owners and managers. It is a report card of the performance of the business, as well as their personal performance during that time frame. Financial statements also provide valuable information about trends in the business and allow management teams to make effective decisions concerning the future direction of the organization. Good bookkeeping practices throughout the accounting period will make the calculation of the financial statements go more smoothly and yield a more accurate result.

The Basic Statements

Compute the ending balance of all of your accounts within your business. Include income and expense accounts, also called temporary accounts, as well as permanent accounts. Examples of permanent accounts are asset and liability accounts. Owner's equity will be calculated during the preparation of the balance sheet.

Prepare a trial balance for your business. This is a listing on a two-column ledger or spreadsheet with all ledger accounts listed with the debit balances shown on the left and the credit balances shown on the right. Total each column. The debits should equal the credits. If the totals do not balance, fix the error or errors in the books before proceeding.

Carry the debit and credit balances from your trial balance to a blank income statement form. This shows all business revenue at the top of the form and accounts for the cost of goods sold. The normal balance for a revenue account is a credit, so enter credits as positive numbers and debits as negative numbers. Enter all expense accounts in the lower section, with all debits entered as a positive balance and any credits as a negative. Total each section and subtract the expenses from the revenue. The result is the net profit.

Carry all permanent account balances to the balance sheet. Subtract the total of all liabilities from the total of the assets, and make this entry under owner's equity. The balance sheet is now completed. Complete the cash flow statement by listing the cash inflows and outflows of the business. This can generally be completed from the checkbook register, and includes cash in or out from any activity, including borrowing or investing.

Key Financial Ratios

Divide the owner's equity by the total amount of liabilities and multiply by 100 to determine the debt-to-equity ratio as a percentage. This reflects how much of the business activities are financed by investment and retained earnings, as opposed to borrowing with loans and other debt instruments.

Calculate the inventory turnover by dividing the cost of sales from the income statement by the total amount of inventory on the balance sheet. The answer is the amount of times the inventory has turned over, or completely sold out within the accounting period. This calculation is most useful on a yearly accounting statement. Many businesses look for four to five turns per year as optimum, but it varies according to the type of business.

Determine the operating margin of the business. This is the amount of each dollar that the business made in revenue that represents profit. Divide the total income that the business received by the net revenues and multiply by 100 to express the operating margin as a percentage.

Tip

  • Take the time to record the key business ratios for each accounting period and analyze trends over time. A snapshot of the numbers for one accounting period will not tell you as much as if the ratio is increasing or decreasing over time.

Warning

  • Have your financial statements audited periodically to ensure that you are reporting your business condition accurately.