Standard Formatting for Financial Statements

In the last lesson Carl pieced together how the financial statements interact; however, he’s starting to think his financial statements look a little shabby. He wonders if there is a standard format for financial statements.

The way a financial statement looks is important. Most financial statements prepared in accordance with generally accepted accounting principles (GAAP) look rather similar. There aren’t really a lot of set rules, but below you will see the general format.

Standard Formatting for the Balance Sheet

The balance sheet always begins with assets and then lists liabilities and owners’ equity. This format clearly reflects the accounting equation (assets= liabilities + owners’ equity). Note that the numbers below are not an actual reflection of Carl’s Clockworks current business. The numbers and accounts have been made up for learning purposes (calm down Carl).

Financial statements like the balance sheet have a standard format.

Now the first thing you might notice is that the assets are grouped into two different categories: current assets and long-term assets. This is pretty standard for the balance sheet. The current assets represent all the assets that Carl’s Clockworks’ expects to be used or converted to cash within the next year. Common examples of current assets include cash, accounts receivable, inventory, and supplies. Most companies plan to collect their accounts receivable within a year and most companies plan to sell their inventory within a year so they are listed as current assets.

Long term assets are those assets that you don’t plan on converting to cash within the next year. Common examples are land, building, and equipment. Most companies don’t plan on selling their land, building, and equipment within the next year.

Current liabilities are all of those obligations that Carl expects to pay within the next year. Accounts payable refers to all the inventory (clocks) Carl has bought on credit (he hasn’t paid cash for them yet). Hopefully Carl plants to pay off his accounts, employees, and taxes within the next year. Otherwise we would have to wonder about Carl’s ethics.

Long-term liabilities refer to those obligations that won’t be paid off within a year. The most common example is a note payable or a loan. Usually companies have several years to pay off large loans. The amount that is due this year should technically be listed in current liabilities, but don’t sweat that for now.

Why is the Balance Sheet set up this Way?

Listing current assets and current liabilities is very helpful for those who are trying to gauge the health of a business. If a company has more current liabilities (or obligations) than it does current assets, then the company is going to be in trouble because it won’t be able to pay off its obligations that are soon coming due. This is usually referred to as a company’s liquidity.

Liquidity of an asset usually refers to the asset’s ability to be turned into cash. If an asset can easily be turned into cash it is highly liquid. Accounts receivable and inventory are usually considered highly liquid assets. However assets like buildings take a lot longer to sell and turn into cash so buildings are considered less liquid.

If a company has more than enough current assets to pay off its current liabilities then its liquidity is good. In other words, its ability to pay off its short-term obligations is good.

Standard Formatting for the Income Statement

As mentioned previously, the income statement lists revenues, expenses, and net income. Here’s a look at an income statement with made up numbers and accounts.

One item worth mentioning at this point is that earnings per share (EPS) number listed underneath net income. GAAP requires that this number be disclosed. This number is easily calculated. If there are a thousand shares of common stock in Carl’s Clockworks then you simply divide the net income by the number of shares. This number shows the amount of earnings for each stock for the year. It’s an important number in the business world because people gauge how much a stock is worth off of it.

We’ll talk more about the standard formatting for the statement of cash flows at a later point. The statement of cash flows is pretty complex. For now just know that cash flows are categorized into three main categories: operating activities, investing activities, and financing activities.

Here's the general idea behind the formatting for the statement of cash flows. Don't add the little fat accountant in yours.

In the coming lessons we’ll learn about accounting systems. The goal of an accounting system is to generate these financial reports Carl has been learning about. It’ll be fun. Really.

Next Lesson: Lesson 9 – What is an Accounting System?

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