What Are The Steps to Prepare Financial Statements?

Combining accounting data into a standardized set of financials is part of the process of creating financial statements. Subsequently, you send the statements to management, creditors, borrowers, and investors, who use them to assess the company’s performance, liquidity, and cash flows.

The steps below are part of the process of creating financial statements.

What Are Financial Statements?

Financial statements are a set of summaries of information regarding the cash flows, financial status, and financial outcomes of an organization. They consist of the cash flow statement, balance sheet, and income statement. To guarantee accuracy and for tax, financing, or investment purposes, financial statements are frequently audited by government entities, accountants, corporations, etc.

The Most Important Financial Statements

The three most common and significant statements are the balance sheet, income statement, and statement of cash flows.

Balance sheet – It is a summary of a company’s assets, liabilities, and shareholder’s equity at a specific time. You may find out when the snapshot was taken by looking at the date at the top of the balance sheet, which is often the conclusion of the reporting period.
The income statement – In contrast to the balance sheet, the income statement covers a period of time, often a year for yearly statements and a quarter for quarterly financial statements. An income statement is a summary of sales, costs, net income, and profits per share.
The cash flow statement – CFS measures how effectively a business earns cash to cover debt payments, operational costs, and investments. The cash flow statement enhances the balance sheet and income statement.

What Are The Benefits?

Here are the benefits of the financial statements.

To assess a company’s capacity for producing cash as well as the sources and use of that cash.
To establish if a company has the ability to pay down its obligations.
To monitor financial outcomes over time in order to identify any potential problems with profitability.
To calculate ratios from the financial statements that you can use to assess the state of the company.
Furthermore, to look into specific commercial transactions that are present in the disclosures that go along with the statements.
To serve as the foundation for an annual report that is sent to the business’s shareholders and the wider financial community.

Steps in Creating Financial Statements

Collect financial information: Gather all documents, including bank statements, invoices, tax returns, and balance sheets.
Analyze the data: Review the financial data to determine trends, patterns, and any potential areas of concern.
Prepare the statement of financial position: Create a statement of financial position, also known as a balance sheet. It shows the company’s assets, liabilities, and equity.
Prepare the statement of income and expenses: Create a statement of income and expenses, also known as an income statement. It shows the company’s revenues and expenses over a period of time.
Prepare the statement of cash flows: Create a statement of cash flows that shows the company’s cash inflows and outflows over a period of time.
Prepare the statement of changes in equity: Create a statement of changes in equity, which shows the changes in the company’s equity over a period of time.
Present the financial statements: Present the statements in a format that is easily understandable to the user.
Analyze and interpret the financial statements: Review and analyze the statements to identify any potential areas of concern and make any necessary adjustments.
Prepare the notes to the financial statements: Create a set of notes to the statements. It will explain any assumptions, methods, and policies used in preparing the statements.

Conclusion

Ultimately, The key to an external assessment of a firm’s performance is its financial statements. The income statement provides information on a firm’s profitability. At the same time, the balance sheet provides information on the liquidity and solvency of the organization. By keeping track of the sources and uses of cash, a statement of cash flow links these two together. As a result, these, taken as a whole, show how a business is doing over time and in comparison to its rivals.

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Key Takeaways

Financial statements summarize financial data for assessment.
Key statements are the balance sheet, income statement, and statement of cash flows.
Financial statements provide insights into performance, liquidity, and solvency.
The statements are crucial for decision-making, assessments, and comparisons.

FAQ

1. What are financial statements and why are they important?

Financial statements are standardized summaries of an organization’s financial data, including cash flows, financial status, and outcomes. They are crucial for assessing a company’s performance, liquidity, and cash flows.

2. What are the key financial statements?

The key financial statements are the balance sheet, income statement, and statement of cash flows.

3. What information does each financial statement provide?

The balance sheet provides a snapshot of a company’s assets, liabilities, and shareholders’ equity.
The income statement summarizes sales, costs, net income, and profits over a period.
The statement of cash flows measures cash earned and used for debts, operations, and investments.

4. Why are financial statements beneficial?

They offer benefits such as assessing cash generation, and obligations, monitoring performance, calculating ratios, analyzing transactions, and serving as a foundation for reports.

5. What are the steps in creating them?

The steps include collecting financial data, analyzing trends, preparing statements (balance sheet, income statement, cash flow), presenting, analyzing, adjusting, and adding explanatory notes.

Accounting, Skills

How to Use Standard Costing and Variances?

Businesses utilize standard costing and variances as a method to monitor their expenses. In other words, it entails establishing a “standard” cost for each good or service and measuring actual costs to these benchmarks. Additionally, you can track direct and indirect expenses using standard costing.

On the other hand, variance analysis is a method for contrasting actual costs with standard costs. This comparison can assist managers in finding areas where costs are greater than anticipated and, if necessary, take corrective measures.

To have a career in Finance, you need to know how to calculate standard costing and variances.

Below is an extract of the lesson on standard costing included in my course.

Defining Standard Costing and Variances

Method
With the standard cost method, you value your product using expected costs rather than actual costs. This simplifies the accounting of producing units.
Definition
The Standard cost of a finished product is composed of the following:

Direct material
Direct labor
Manufacturing overhead

Direct material = Material standard price x standard material quantity for one product
Direct labor = Labor standard price (hourly rate) x standard number of hours used for one product
Manufacturing overhead = Overhead (indirect costs of manufacturing) allocated to one material using an allocation key.

Variance

For each of the three components listed above, there are 2 sources of variance: the usage and the price.
For example:

Direct material will have a usage variance: how many quantities were used vs the standard quantity
Direct Material will also have a material price variance: actual price vs standard price multiplied by actual quantity

Also, here is an example, and you can find this template in the course.

Other Types of Cost Accounting

Activity Based Cost Accounting
Marginal Cost Accounting
Lean Accounting

The Bottom Line – Standard Costing and Variances

In every manufacturing or production process, standard cost variances are a necessary component. Therefore, to find out what is causing these variations and how to fix them, variance analysis is utilized.

Furthermore, an instrument for managing these variances is standard costing. As a result, they are very important to learn if you are pursuing a career as a finance professional.

In my online course I have 77 other chapters where you can learn from me the concepts to accelerate your career in finance.

Accounting

What is Activity-Based Costing in Finance?

The manufacturing sector uses activity-based costing (ABC) most frequently because it improves the accuracy of cost data. Also, it is effective in identifying the expenses a firm incurs throughout the production process.

Therefore, here is everything you should know about activity-based costing if you are a finance professional.

Definition of Activity-Based Costing

Activity Based Costing (ABC) is a cost accounting method.

ABC is a method of assigning costs to products or services based on the specific activities or resources that are consumed in their production or delivery. Also, it is an alternative to traditional costing methods, such as job costing or process costing, which assign costs based on a more general allocation of overhead costs.

Specificities

In traditional cost accounting, overhead costs are allocated using only one arbitrary rate. But, ABC allocates the overhead more accurately.

How?
By arranging overhead activities in cost pools.

Cost pools

A cost pool is a group of costs either based on the following:

a cost center,
a group of cost centers or
a measurable activity (measured as a % of the total time spent by a group of people).

For example, cost pools can be:

Warehouse management
Customer service
Maintenance
R&D
Technical training
Warranty costs

Measures

After defining cost pools, you need to define the unit measures. Additionally, you will use the unit measures to allocate the cost pools to the products.
For example, unit measures can be:

number of units produced
number of orders
amount of material used
percentages
square meters used

Advantages and disadvantages of the Activity-Based Costing Method

Pros

More Accurate
Also, you can use multiple rates
Yet, a better view of the profitability of a product
Furthermore, it can help reduce the structure cost by choosing activity having a heavy impact on product cost

Cons

Difficult to implement
In addition, you can not use it for external reports as you mix COGS and SGA in the product costs
Needs to have the right level of details
Moreover, needs consistency of the methods
Overhead costs not directly allocated

Case study

#1: Let’s imagine a manufacturing company called “TOP DESK.” They produce desks for offices. They have two products: a standard desk and an electric standing desk.

#2: They have 10M€ overheads related to the products:

Logistics: 5M€
R&D: 2M€
Customer service: 2M€
Warranty & repairs: 1M€

#3: Traditional cost accounting:

Overhead is allocated to each direct hour. Let’s say there are 500,000 direct hours worked.

10,000,000€ / 500,000 = 20€ overhead per hour

#4: Activity-Based Costing accounting:

#5: Comparison:

Traditional Cost accounting: overhead allocated based on total direct hours worked for each product.

#6: Comparison: ABC: overhead allocated based on activity:

#7: Conclusion:

Finally, having a more accurate overhead allocation method helped improve the transparency of the profitability of each product.

The case study I presented here shows how two different products can have different profitability based on the type of cost accounting you use.

On the one hand, in traditional cost accounting, the electric desks had a lower overhead allocation as the allocation was based on the number of direct hours used to produce electric desks.

On the other hand, in the ABC method, the allocation was more precise and accounted for the fact that electric desks used more R&D and warranty costs than the standard desks due to their complexity. As a result, the electric desks were less profitable using the ABC method than using traditional cost accounting.

Critics of The Activity-Based Costing Method

However, like everything in Finance, ABC is not the perfect method that fits all businesses (see cons). Additionally, some other methods allocate the overhead directly to specific activities.

The Bottom Line

To sum up, use this method when you have difficulties understanding the profitability of your products and you notice that using an arbitrary overhead allocation key penalizes or favorite too significantly one product.

Then, make sure you use this information for your Go-To-Market Strategy in order to maximize the profit of the business based on its resources.

Also, if you want to receive more finance tips like this, feel free to sign up for my newsletter. If you subscribe, every week, you will receive an email from me where I share best practices, career advice, templates, and insights for Finance Professionals.

Accounting, Finance

Year-End Closing Process: 3 Areas of Focus in Finance

What do you need to do in the year-end closing process? If you are working in Finance just like me, chances are that it’s getting busy.

In addition to the day-to-day activities, there are three things you should do to finish the year well.

Assess Your Balance Sheet Positions

One of the main accounting principles is the accrual principle. First, the transactions need to be recorded in the right period. After that, you need to review your balance sheet positions and book any impact on your profit and loss.

For assets: Review their value, and if needed, you need to book an impairment.
For provisions: Update your assumptions to your best knowledge to have an accurate provision.
Most importantly, remember to document these steps!

Furthermore, here are some areas to have a specific focus on at year-end:

Personnel/HR provisions
Litigations
Bad debts
Stock
Warranty
Invoices not received
Any fixed or immaterial assets no more in use

Prepare Your Landing Scenario for The Year-End Closing

Now that you are closing in November start working on forecasting December. As a result, identify the risks and opportunities on your last forecasting. Then, discuss it with your business partners and your management. Moreover, in your exchanges, you will identify what are the key levers to make opportunities happen and mitigate risks.

Collect Cash

Most certainly, a lot of companies have included their operating cash flow as part of their objectives. Therefore, this means that the management can request the finance team to make an additional effort to maximize the cash collection.

The Bottom Line – Year-End Closing Process

Ultimately, being prepared, organized, and proactive with accounting practices throughout the fiscal year is the key to a smoother year-end closing process.

Also, let me know if you have any remarks or questions on this topic!

Moreover, if you want to receive more finance tips like this, feel free to sign up for my newsletter. If you subscribe, every two weeks, you will receive an email from where I share best practices, career advice, templates, and insights for Finance Professionals.

Accounting

Difference between Cash Vs. Accrual Method in Finance

The timing when revenue and expenses are recorded is the key distinction between the cash vs. accrual method. Therefore, do you understand the difference?

Also, based on these two principles, you can define the two different accounting methods to use.

Cash Vs. Accrual Method

Here are the differences, benefits, and accounting of the cash vs. accrual method.

Cash Method

Cash movement is recorded when a payment from a client is received (cash in) or when a payment from a supplier is made (cash out).

Furthermore, cash-based accounting recognizes revenues when cash is received and when expenses are paid. However, this method does not recognize accounts receivable or accounts payable.

Additionally, it’s easy to understand and display your current cash balance. Taxes are only due on money that has been received rather than on invoices that have been issued, which may improve the cash flow. Contrary to its name, cash basis accounting is unrelated to the payment method you accept.

As a result, you may do cash accounting while being paid online. Finally, small businesses use the cash-based method more often due to its simplicity.

Accrual Method

The accrual principle is revenue recorded when work is done or/product changed hands legally. Furthermore, expenses are recorded when the service is incurred or when a good is received.

Accrual accounting is a method where revenues and expenses are recorded when they are earned, regardless of when the money is actually received or paid.

Moreover, you will have a lot more accurate view of the financial situation and business performance. Alsop, you have far greater confidence while making financial judgments. Therefore, this method is used by middle and big companies to reflect the economic reality of debit and credit positions as well as the income and expenses in a specific period of time.

Conclusion – Cash Vs. Accrual Method

To sum up, I suggest you use the accrual method if your company has a large amount of inventory. If you have a smaller company that doesn’t hold inventory, you will find the cash method to be more effective.

What do you think are the advantages of each of the methods?

Accounting

What Is Deferred Revenue and Expenses?

Have you ever heard about deferred revenue and expenses but never clearly understood what it means?

The success of every firm or individual in finance depends on having a solid foundation in accounting. As a result, recording deferred revenue and expenses on the accrual method of accounting may aid in matching income and expenses to the dates they are received or spent.

Additionally, it enables you to assess the income statement and comprehend the profitability of an accounting cycle more accurately.

Learn more about it in this article.

What Is Deferred Revenue?

Deferred revenue is generally the part of the revenue you invoiced in advance for products or services that are going to be performed in the future.

Examples of deferred revenue:

Imagine you own a software company, and you invoice for a one-year subscription. Furthermore, you will recognize 1/12 of this amount as revenue each month. Therefore, the rest stays in deferred revenue on the balance sheet.

What Are Deferred Expenses?

Deferred expenses are costs that have been invoiced from your suppliers but not incurred. Usually, these expenses are for goods or services that will be used in the future.

Examples of deferred expenses:

You receive the invoice for the cost of a service (generally, it’s also when you pay in advance) that will be provided in the next 12 months. Then, the cost of the service is deferred, and each month, 1/12 be recognized as an expense.

Usually (but not always), for simplification purposes, companies recognize the invoices as deferred when they have paid or received the cash. In addition, It helps them to reduce the payable/receivables accounts for services that are not received or executed.

The Bottom Line

Did this small lesson help you? I hope you have a better picture of deferred revenue and expenses now. Also, let me know which topics you would like me to cover in the future.

For broader lessons on similar and different topics, you can take my course and improve your knowledge.

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What Are The Steps to Prepare Financial Statements?

What Are Financial Statements?

The Most Important Financial Statements

What Are The Benefits?

Steps in Creating Financial Statements

Conclusion

Key Takeaways

FAQ

1. What are financial statements and why are they important?

2. What are the key financial statements?

3. What information does each financial statement provide?

4. Why are financial statements beneficial?

5. What are the steps in creating them?

How to Use Standard Costing and Variances?

Defining Standard Costing and Variances

Variance

Other Types of Cost Accounting

The Bottom Line – Standard Costing and Variances

What is Activity-Based Costing in Finance?

Definition of Activity-Based Costing

Specificities

Cost pools

Measures

Advantages and disadvantages of the Activity-Based Costing Method

Pros

Cons

Case study

Critics of The Activity-Based Costing Method

The Bottom Line

Year-End Closing Process: 3 Areas of Focus in Finance

Assess Your Balance Sheet Positions

Prepare Your Landing Scenario for The Year-End Closing

Collect Cash

The Bottom Line – Year-End Closing Process

Difference between Cash Vs. Accrual Method in Finance

Cash Vs. Accrual Method

Cash Method

Accrual Method

Conclusion – Cash Vs. Accrual Method

What Is Deferred Revenue and Expenses?

What Is Deferred Revenue?

What Are Deferred Expenses?

The Bottom Line

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