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1. Balance sheet
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205 days before opening

1. Balance sheet 2. Income statement 3. Cash flow statement 4. Do it yourself 5. Coaching


Financial statements are the basic elements you need for starting and managing any business.

Any new investor has to establish a first balance sheet. Moreover, all the business plans must include several projections about three main financial statements and notably the cash flow projections.

In this crucial module, we shall work with the figures coming from our previous accounting module. Starting with these basic figures, we shall establish a balance sheet, an income statement, a cash flow statement.


Lesson: 5 hours

External readings: 3 hours

Do it yourself: 13 hours

Total: 21 hours


The objectives are:

-To show you the main components of a balance sheet.

-To give a global overview of the income statement and of its components

-To explain you the main components of the cash flow statement with their functional meaning

-To show you how to make up your cash flow projections and how to use it.

By the end, you will be able to set up your own balance sheet, income statement and cash flow projections.

1. Balance sheet 2. Income statement 3. Cash flow statement 4. Do it yourself 5. Coaching


A balance sheet shows the relations between what you have (the assets) what you owe (the liabilities) and what you have invested in the biz (your owner's equity)

11-Main components

The table and the two drawings show the balance sheet at the end of 2000 and the following balance sheet at the end of 2001 (12/31/2001).







14 000

14 000

Marketable securities


2 000

Account receivable ( clients )

5 000

3 000

Inventories (stocks)

5 000

10 000

Total current assets

24 000

29 000

Property and equipment

3 000

6 000

Less depreciation


(1 000)

Net property and equipment

3 000

5 000



4 000



2 000

Total assets

27 000

40 000



Account payable

3 000

9 000

Note payable


6 000

Current portion of long term debt


2 000

Total current liabilities

3 000

17 000

Long term debt

7 000

5 000

Total liabilities

10 000

22 000


17 000

18 000


27 000

40 000

Right now, just focus on the first column of the table and the following Drawing 1 regarding the balance sheet at the end of year 2000.

As you can see, the figures are those of the first balance sheet we have set up in the "book keeping module". So, recall this module and you will easily understand.

DRAWING 1: Balance sheet - 12/31/2000

What can you observe? You observe that there is a complete equality between the assets and the total liabilities and equity.

This basic concept means that in order to acquire assets, a company must pay for them with the owner's money (equity) or with the money he has borrowed (liabilities):

In the accounting module we began the operations with a sum of money coming from the owner (equity). As this sum of money was by itself an asset (cash), our first balance sheet appeared as follow:

ASSETS (cash) = EQUITY(owner 'money)

With further operations, we have borrowed to suppliers and bank (liabilities) and finally our final equation is as below:

ASSETS (27000) = LIABILITIES (10000) + EQUITY (17000)

All the balance sheets rely on this equality. If your balance sheet does not balance, it means that your accounting is false!

Look at the following Drawing : One year later the balance sheet relies on the same equality:


DRAWING 2: Balance sheet - 12/31/2001

Look at the above drawing. You can observe two things:

-The assets are subdivided into current and long term assets ("other assets" on the drawing). The liabilities are divided into current and long term ( "others" on the drawing).

"Current" includes the assets you can convert in cash within one year and conversely it includes the liabilities ( or the debts) that you have to pay within a one year time frame. "Current" means short term both for assets and debts.

Of course, this distinction is very important and and we shall deal with it with the financial analysis module. Right now, you can imagine that a company that have current liabilities and zero current assets should be in a very difficult position!

-On the table summarized by the drawing, current Assets and liability are listed in first. Inside the "current" both assets and liability are listed in order of their liquidity from most to least liquid. Liquidity means the ability of an asset to be converted into money and the ability of a liability to be paid in short term.

Of course, among current assets, cash is listed first. Among the current liabilities, the accounts payable to suppliers are listed in first because suppliers are not accustomed to wait for their money.

In some countries , it's just the contrary: assets and liabilities are listed from the least to most liquid. For example, in such a balance sheet, long term assets such as land or machinery are listed in first and among the equity and liabilities, equity is listed in first followed by long term debt. Consequently, you have to go at the down of the balance sheet for examining the cash and notes payable.

Down earth advice:

Of course, long term is beautiful. Unfortunately, bankrupt is a short term issue! If you are living in a country, with this balance sheet presentation, take the habit to draw for your personal use a balance sheet organized from most liquid to least liquid.

What is more, take the habit to establish the same drawings as above. At first glance, they give you a sound outlook of the situation.

12-Assets and liabilities

We shall limit this lesson to the description of the different accounts used in a balance sheet. In a further module, we shall teach how to analyze them.


1211-Current assets:

Current assets can be easily converted in cash within a short period. The following are the current assets:

-Cash: Cash means cash money in the company’s checking and saving accounts. It's the most liquid of all current assets and is listed at the top of the balance sheet.

Down earth advice

People say that cash is the king. Although cash in bank does not bring too much profit because interest on day to day money are often low, a new and small biz have interest to keep a good amount of cash: It gives you a feeling of security and help to deal with the stress often incoming when you are just starting your business.

Marketable securities: Marketable securities are short term investments in government securities or commercial papers of other firms. They have short maturity and stable prices. They are referred to near cash assets.

Account receivables: Account receivables are amounts owed by customers who have purchased goods and services from the company on trade credit. Of course, If you have given credit to a customer who cannot pay, this account will be diminished by a depreciation often called allowance for bad debts.

Down earth advice

The increase of "account receivables" can mean that your sales are on the rise and that all is OK but it can also signify that bad debts are increasing! I recommend you to check this account at least every month and if possible, every week.

- Inventories: Inventories are goods ready for sale or still in the manufacturing process; raw materials, unfinished and finished goods.

The value of inventories depends on the accounting system like FIFO and LIFO (recall accounting module). What is more, the inventories suffer of a physical depreciation and of changes in fashion: For this reason, the accounting value of clothes inventories is often overstated. On the contrary, some products get an increasing value with the years: Fine wines, some alcohols like Cognac, vanilla and so on. As a result, there is always a large uncertainty about the real liquidation value compared to the accounting value.

1212-Long term assets:

They are divided into fixed assets, depreciation and intangible assets.

-Fixed assets refer to Property, plant and equipment, buildings, land and machines owned by the company. They represent long term illiquid investments and support a depreciation (except for land).

In the balance sheet, you have the original value of the fixed assets, the amount of depreciation that should be deduced, and finally the total fixed assets which represent the value of the fixed assets less the accumulated depreciation. For example, look at the 2001 balance sheet table. You can see: Property (6000) less depreciation (1000) = Net property (5000)

-Intangibles: Intangibles are trademarks, patents, design etc. It's very difficult to estimate their real value.


Liabilities are all the debts and obligations a company owes to outside people such as suppliers and banks. Once again liabilities are divided into current and long term liabilities.

1221-Current liabilities:

They include all the debts and obligations a company must pay within a short period (less than one calendar year). The following are the current liabilities:

-Account payable: Account payable means the company’s debt to its suppliers.

-Note payable: Note payable include commercial papers or promissory notes. These notes must be paid within a year.

-Accrued expenses: They includes some expenses owed to employees or the State (For example: income tax) that are owed but have not been yet paid.

-Current portion of long term debt: The current portion of long term debt is the portion of these debts owed to the banks on the coming year.

1222-Long term debt:

-Long term debt is debt due after one year from the date of the balance sheet.

13-Owner’ equity

Owners’ equity or net value is the amount left for the company’s owners after subtraction of liabilities from the assets.

In the balance sheet (12/31/2000):

Assets (27 000) — liabilities (10 000) = owners’ equity (17 000)

In a corporation, ownership is represented by a capital stock. A share of stock is one unit of ownership. Investors buy stocks in order to share the company’s profits.

I underline, once again, that it's just a description of the account. We shall deal with the return on equity (ROE) in a next module.

External readings and quiz:

Go to : It's a web site for students at the University of Arizona. Click on " Basic financial statements" and then on "The balance sheet". You will get here a complete description of the accounts and a quiz to do.

1. Balance sheet 2. Income statement 3. Cash flow statement 4. Do it yourself 5. Coaching


The income statement is one of the most basic elements that you have to know.

21-Global overview

We start with the figures coming from the accounting module. Look at the first column of the table (12/31/2000). The income statement shows the company’s revenues and expenditures over a fiscal year. Once again there is a basic equation:

Revenues — expenses = income

-Revenues include sales interest, fees, commission, rental income and so on. In our example, the only revenue is sale.

-Expenses include cost of good sold, interest paid to bank and creditors, rent, depreciation, income tax, salaries and so on

-Profits or loss result from the combination of revenues and expenses.




Sale to customers

10 000

15 000

Cost of goods sold

3 000

6 000

Gross income

7 000

9 000

Less selling, general and administrative expenses




3 000



2 000



1 000

Operating income

7 000

3 000

State income taxes


2 000

Net income

7 000

1 000

The balance sheet shows accounts with accumulating sums since the beginning of the company. On the contrary, the accounts of the income statement shows zero at the beginning of the year. For example the account "sales" is the amount of sales made during one year and not the amount of sales realized since the beginning of the company.

Consequently, you have to take notice that the figures of the income statement are not coming from the balance sheet.

22-Main components


The sales figure represents the amount of money the company gets from its customers in exchange for its products.

A more detailed description takes in account the gross sales minus rebates, returns and allowances. It gives the net sales.

222-Cost of goods sold

These costs include the cost of raw materials, parts, labor costs, and costs of operating machinery. For a simple retailer, cost of goods sold equals the price he paid to suppliers for the merchandise he sells in his store. Cost of goods sold (COGS) is calculated by this formula:

Inventory at the beginning of the year + New purchases within the year + Labor costs + Operational costs machinery - Inventory at the end of the year = Cost of goods sold.

It means that cost of goods sold is a complex figures. It does not come like the sales from one account and you have to make a bit of calculations between different accounts to get it:

-Inventories at the beginning and at the end of the year come from the balance sheet. The inventory appearing on the balance sheet of year 1 is the beginning inventory of the balance sheet closing year 2.

What is more these calculations are affected by the accounting principle used (FIFO, or LIFO, recall the accounting module)

Real life example:

Valuation of inventory has a large effect on the cost of goods sold. Many years ago, I had to study the income statement of an agri business company located in Madagascar. I observed that the level of inventory at the end of the year was the only cause of the increasing income. So I decided to check this inventory by myself.

Inventory was mainly made up of sacks of rice stocked by piles of five meters high, five meters large and five meters in length just like some little cubic buildings. You had just to count the buildings to get the total volume in cubic meters and consequently the exact number of sacks and their total value.

Unfortunately, I asked the people to remove the first line of sacks because I wanted to see inside the "cubic buildings". People became angry but did it. Then, I discovered that the buildings were in fact empty! As a result the positive increasing income turned to be a massive loss!

-New purchases, labor costs, parts of machine are not found in the balance sheet and comes from the accounts on the general ledger. Labor cost include only the salaries paid to people working on production such as floor shop and so on. It does not includes the salaries and commissions paid to salesmen or to back office employees. For example the salary of your accountant is not in the labor costs.

Globally, costs of goods sold refer mainly to the variable costs ( refer the economic module)

As you can see, the cost of goods sold is not easy to establish. It's the most difficult component of the income statement.

Down earth advice:

When describing the income statement, small biz web sites on the web do not go to the specifics and their readers can think that all these calculations are easy. In fact, many of these "advisors" have never put their nose in a real general ledger and just provide with second hand information's that they have collected in books. As you can see, to set up an income statement is not easy!

Our goals are to make you understand the mechanisms of the income statement and to enable you to set up your first own. Learning in doing is the best way to understand but, once again, for further or more complicated operations, I recommend you to use an accounting consultant firm.

223-Gross income

Gross income (or gross profit) equals sales less cost of goods sold.

At this point, you can determine if the company is making profit without considering the burden of corporate expenses.

If a business has a negative gross income, costs are out of control or the prices of the goods you sell are too low.

Real life example:

When I was banker, I was accustomed to begin any income statement examination with the gross income figure. When this figure was negative, I did not go on any much and I just said "No" to any loan request.

Down earth advice:

When writing your financial statements, begin with the account giving the gross income. If this figure is negative, it's not worth to go on. With a negative gross income: No future for your business! It means that there is something wrong in your idea or in your project.

224-General and administrative expenses and depreciation

General and administrative expenses (sometimes called operating costs) include salesmen salaries and commissions, marketing and advertising expenses, administrative expenses (phone, letters, travels) and costs of all support functions: human resources, accounting, finance, salaries of the management. These expenses do not include the financial costs ( interest due to banks)

-Depreciation is the cost of equipment, tools, buildings and other fixed assets divided by their useful lives to estimate the cost of depreciation within one year( recall the accounting module). Once again, the rate of depreciation depends on the accounting principles chosen regarding the taxes. With high depreciation rate you diminish the net income and consequently you pay less income tax. On the other hand, your banks and suppliers can think that your company is not profitable. It means that the rate of depreciation is a difficult issue and requires sound advices.

225-Operating income

Operating income equals gross income less general and administrative expenses and depreciation.

This operating income excludes the other incomes coming from activities external to the core company business ( see further). It excludes also the interests owed to creditors such as bank and the income tax.

When the operating income differs too much from the gross income, it means a poor management and too much fixed costs. On the other hand, be aware about the depreciation policy!

Real life example:

Gross income is very easy to analyze. On the contrary, operating income calls for a careful and complex analysis. That is in this field that you can take measures in order to reduce fruitless or luxurious expenses.

On the other hand, I had met a lot of companies with negative operating income due to massive depreciation. These companies were in fact very profitable but instead of distributing dividends or paying income tax, they had chosen to show accounting losses and to accumulate massive cash provisions.

226-Other and unusual operations, income tax

Other expenses or incomes are generated outside the core business of the company such as renting of idle buildings or speculation profit on foreign currencies, and of course interests due to creditors.

Unusual incomes or loss occur when an extraordinary event such as natural disaster results in profit or loss.

Finally, operating income less other and unusual operations gives a result which supports the income tax.

Then you get bottom line: the net income.

227-Net income

Net income equals operating income less provision for income tax, less interest due to bank and + or - some others and unusual incomes.

The net income is the crucial figure. It's what you have really earned when all the expenses have been taken into accounts. For example, you can read from the income statement that the business had a net income of 1 000 (12/31/2001). This net income explains why the owner's equity pass from 17 000 on 12/31/2000 to 18 000 on 12/31/2001, on the balance sheet.

In a large company, this net income is divided into two parts: the dividends which are paid to the stockholders and the retained earnings which are kept inside the company for investing in the future.

External readings

Once again, go to . Click on "basic financial statement" and then on "income statement". You will get here some complementary knowledge's about the earning per share.

1. Balance sheet 2. Income statement 3. Cash flow statement 4. Do it yourself 5. Coaching


The cash flow statement is the third major component of financial statements along with the income statement and the balance sheet.

31-Main components

As for the income statement, the cash flow statement covers only one year . The next table shows the cash flow statement at the end of 2001. It compares the Figures representing increase or decrease of the accounts between 12/31/2000 and 12/31/2001 (The numbers between parenthesis are to be restrained).

As you can see on the table some figures are coming from the income statement and some other from the balance sheet.

Recall that an increase in an asset is a use of cash, while a decrease in an asset is a source of cash. Conversely, an increase in a liability or owners equity account is a source of cash, while a decrease is a use of cash

The cash flow statement is divided into three parts: Operating activities, investing activities and financing activities

311-Cash flow from operating activities

The most important component is cash flow from operations. The figure appears line D. It gives information's about the core and current business. A diminishing figure over years indicates that your company is having troubles for example with sales and the collect of account receivables.

In a well managed company, the cash flow from operating activities must be quite equal to the figure of the net income. It's not the case in our example and you can observe a strong increase of accounts and notes payable. It means that one part of the cash is coming from the suppliers because in this example the payments are delayed!

The cash flow coming from operating activities must be positive.

Real life example:

There are some stupid fads in business as everywhere. It has been said (and taught!) that it was a good thing for the fast growing companies to consume ( or to burn) more cash than they should generate. More the cash flow coming from operations was negative and more the company was expected to grow! This cranky story has ended with the burst of the tech bubble!

312-Cash flow from investing and financing activities.

Cash flow resulting from Investing and financing activities can be positive or negative. Purchase of equipments results in outflows and in our example the pay back of a loan results also in outflows of cash.

In a well managed company, investing and financing components must generate a negative cash because it shows that the company is able to pay back its debts (outflow of cash) and to finance by itself its investments (outflow of cash)

A positive cash could mean that the company is selling its long term assets: It's not a very good sign!. On the other hand, a positive cash could also mean that the company borrows massively to invest (inflow of cash coming from bank)

313-Cash result

The bottom result shows the net change in cash for the year. In a well managed company (it's not the case in our example!) the net change of cash must be positive every year and of course the cash at the end of the year must also be positive!

In summary the cash flow statement shows where cash comes from and how it is spent.

You can have a high net income and be forced to borrow heavily just to stay alive. Another company can throw off cash even with a good net income. The balance sheet and the income statement do not give this information.

The cash flow statement is a management tool to avoid liquidity problems: Inability to manage cash is often the main cause of bankruptcy.

32-Cash flow projections

The cash flow statement is not a forecasting. Then, you have to do a cash flow projection month after month on a regular basis. It's the only way to be sure you will be able to pay your bills and meet other financial obligations.

The next table shows a cash flow projection:








Cash receipt



















Cash expenditures























Raw materials







Income tax





















Net cash flow

+ 958

- 81

- 64

- 85

+ 15

- 45

Cumulative cash flow

+ 958





+ 698

321-Cash receipts

Cash on hand: the "capital" is called cash on hand. It's your cash at the beginning of the first month of your projection.

When you make up your first projection, It is better to write zero for cash on hand. When the projection over ten months is complete, you can exactly determine what is the amount of cash you need: It's the most important monthly figure of your cumulative negative cash flow.

Sales: This line records the sales and services and other receipts. You have to record these receipts in the month you get the money in bank and not the month the sale is closed and the invoice sent to the customer. A sale in cash is cash in the bank! Orders and invoices are not cash receipts.

You have to be very cautious because it could take a long time between the invoice and the real cash of money. It's the banking job to lent the money during this lag but recall that a small new biz cannot relies on banks.

In this example, you can see that the cumulative cash flow decreases because fixed cost must be paid from day 1 in a new company’s life and sales need time to become cash.

Down earth advice:

Increased sales could diminish the cash flow!

let 'suppose that your sales are purchased on credit and let's suppose that you pay cash the raw materials you need to produce. As sales increase, you have to purchase more and more raw materials. As a result, the more you sell and more your cash flow diminishes!

It means that you have to manage both trade credit for your customers and from your suppliers. What is more, you have to manage accounts receivable and collect rapidly past due accounts. Recall that the longer your customer balance remains unpaid, the less likely you will collect the payment!

322-Cash expenditures:

Cash expenditures or cash paid out related to fixed costs are known and can be projected with accuracy. It is more difficult for variable costs as raw materials.

Operating expenses: You have to note every expense in the month it will be paid, and not the month it is incurred: The list in the table is just a summary.

Down earth advice:

Experience shows that most people very often forget one or several items. The best way to correct that is to add a provision of about 10% of the expenses as final line in the monthly total expenditures.

Other costs: You will find here loan principal payments, investing expenditures such as the purchase of a car, and the unusual spending's that we have seen in the income statement. Unfortunately, most of these unusual spending's cannot be forecasted!

Finally, you get your monthly cash position and most important your monthly cumulative case flow.

Each day, when entering your desk, you must consult the cash flow situation of the day: What is the amount in cash this morning? How much do I have to pay today?

323-Adjusting the projections.

These projections must be adjusted every weeK. It means that you confront what has really happened with what had been projected. It enables to establish with the time more and more precise projections.

When you will be trained, you should be able to forecast balance sheet, income statement and cash flow statement over three years with an astonishing accuracy! We do not believe in forecast over 10 years!

1. Balance sheet 2. Income statement 3. Cash flow statement 4. Do it yourself 5. Coaching

Lesson summary:

1-The key of any balance sheet is in the basic accounting equation: Assets must equal liabilities plus owner's equity.

Assets and liability are listed on the balance sheet from most to least liquid. Among assets, current assets have the ability to be converted quickly into cash. Among liabilities, the current liabilities are short term obligations that will have to be paid within a year.

Owners’ equity is the result of assets less liabilities. It's also called net worth or net value.

2-The income statement shows the company’s revenues and expenditures over a fiscal year. Once again there is a basic equation:

Revenues — expenses = income

Revenues include sales, interest, fees, commission, rental income and so on.

Expenses include cost of goods sold, interests paid to bank and creditors, rent, depreciation, tax, salaries and so on

Profits or losses result from the combination of revenues and expenses.

3-The cash flow statement shows where cash comes from and how it is spent.

The cash flow statement is divided into three parts: Operating activities, investing activities and financing activities

The most important component is cash flow from operations. A diminishing figures over years indicates that your company is having troubles for example with sales and the collect of accounts receivable.

Then, you have to do a cash flow projection, month after month on a regular basis. It's the only way to be sure you will be able to pay your bills and meet other financial obligations.

 1. Balance sheet 2. Income statement 3. Cash flow statement 4. Do it yourself 5. Coaching



Assemble the spreadsheets coming from:

-FW15: Your projected sales and revenues

-FW17: Your global grid costs both for the starting and the running periods.


-Your balance sheet departure

First step: It's easy: you put in owner's equity the money you have invested. I suppose that you have no debts so there is nothing to post in liabilities. Then you indicate in the assets the cash you have in your cash register.

Second step: You plan to order some equipments and some inventories for starting. You put them in the assets and you diminish the cash. Of course the owner's equity does not change.

It gives you a first overview of your balance sheet departure.

-Your projected income statement

You do as indicate in the lesson. You get a result negative or positive.

-Your projected balance sheet as it should appear one year after your opening

First step: Regarding the assets, you put in inventories the final inventories as it results from your income statement. Then you apply the depreciation to the fixed assets.

Second step: Due to these change the gross total assets is different from the total of owner's equity+ liabilities.

If the asset surpass you put the difference for balancing in the owner's equity. It is a positive result.

If the total assets is below the total liabilities +owner's equity, you diminish with the same amount your owner's equity. It is a loss.

in the two case the two components must always remain absolutely equal.

-Your income statements and balance sheets on the next three years

Do as above.

-Your cash flow projections during the starting period

It's easy because between this period you do not expect receipts. So you just post the expenses week by week.

-Your cash flow projections during the first running period

Once again post expenses and receipts week by week.

-Your cash flow projections on the next three years.

Here you can do it only month by month

3-Insert in your business plan

Open your plan ware folder and insert these works under the proper chapter.

 1. Balance sheet 2. Income statement 3. Cash flow statement 4. Do it yourself 5. Coaching


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