And second, we prepare the income statement that talks about profitability.
So the balance sheet that we had of December 31st of year x1,
was the following that you see here on the screen.
The balance sheet, also called the statement of financial position,
gives a picture of the company with all the sources of capital and
all the uses of capital.
Any accounting transaction affects the balance sheet,
at least two accounts of the balance sheet, so that the basic accounting
equality assets equal owner's equity plus liabilities always holds.
However, the limitation of the balance sheet is that this is static, so
it only gives you the ending balance of each account.
So the only way to know what happened to the business during the year is by
comparing the ending balance with the beginning balance.
Now, as a shareholder in the firm,
it is very possible that you want to learn more about certain accounts that can give
you more information about how the business has performed during the year.
One of such accounts is the profit and
loss account that will tell you what profitability.
How did the operations contribute to the net worth of the shareholders
during the year?
How efficient are we in our operations?
This is why we need a vision of financial statement that analyzes the profit for
the business.
This second financial statement is the income statement.
And we start as you see by sales, that's the top line, and
then minus the cost of goods sold, we have the gross margin and
you keep going down until you get the bottom line which is the net profit.
And the net profit is the increase in the net worth of the shareholders,
thanks to operations.
So the income statement is not a picture but
a sort of a movie of what happened with operations during the year.
This is why we talk about the income statement for a period of time, for
year x1 in this case, as opposed to for a specific date.
As important as being profitable is having cash,
because at the end of the day profits should translate into cash.
As mentioned earlier, this week we're going to introduce a new financial
statement that is going to analyze what happens with the cash account.
So the cash flow statement will help explain the change in cash for the period.
It will give us information about the liquidity of the business.
Okay, before we start with your next two transactions, I would like to make
a couple of clarifications about how the accounting process works.
So in the next video, I'm going to introduce the T-account and
journal entries.
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