An absolute beginner’s guide to accounting and reading financial reports

For those who’ve not studied accounting, reading a financial report can be an immense headache.

For example, how do you differentiate between gross profit/gross margin/sales profit/gross income? It’s a trick question: they all mean the same thing.

So if you’re keen to learn accounting but aren’t eager to sit through a whole course (or maybe you’ve learned it but need a handy reference), here’s a guide.

Suppose you own an apple farm. How do you track the financial activities of your business?

First, a financial report consists of a balance sheet, which lays out your assets, liabilities, and shareholder’s equity within a specific time frame. Next, an income statement indicates your revenues and expenses. Finally, a cash flow statement reveals the amount of cash or cash equivalents entering or leaving the company. Many financial reports have a unique way of showing negative figures. Instead of -$100,000, it’s written as ($100,000).

Let’s break it down further.

The balance sheet

Assets

Assets are the resources that you own. Your farmland, the apples, and farm equipment: they’re all assets.

Current assets can be converted to cash within a year. In the real world, a company’s cash and inventory can be considered current assets.

Non-current (or fixed) assets are long-term in that they’re hard to convert to cash within a year. In the real world, your factories, equipment, and buildings can be considered fixed assets.

Intangible assets are resources that are not physical in nature. These include copyrights, patents, and trademarks.

The value of your assets can depreciate or appreciate over time. In your case, apples that have been plucked will depreciate in value rather quickly, since they will rot within weeks.

Liabilities

Liabilities are things that you owe other people. These include: loans, deferred payments (revenue you’ve received for a service you’ve yet to render), and accrued expenses (expenses that are due in the future).

Preference shares (or preferred stock) is considered a form of equity, but it’s often listed as a liability if it’s redeemable, in other words, if the company can buy it back at a later date for an agreed-upon price.

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The income statement

Types of expenses

Revenue (sales/gross income/top-line)

Gross profit (sales profit/gross income)

Non-operating income (other/incidental/peripheral income)

Measures of profitability

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Cashflow statement (CFS)

Operations

Investment

Financing

Net change in cash and cash equivalents

Net cash and cash equivalents

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Evaluating financial reports

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