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How to Prepare the Basic Balance Sheet and Statement of Cash Flows

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  • 0:36 The Balance Sheet Recipe
  • 1:08 Balance Sheet Format
  • 1:52 Creating the Balance Sheet
  • 4:42 The Statement of Cash Flows
  • 9:04 Lesson Summary
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Lesson Transcript
Instructor: Rebekiah Hill

Rebekiah has taught college accounting and has a master's in both management and business.

There are four reports that make up the financial statements. In this lesson, we will talk about how to create the balance sheet and the statement of cash flows. You will learn how to format the reports, as well as what information is reported on them.

Who's the Boss?

Good day, everyone. I am Mrs. GAAP, and in the accounting industry, I am the boss. My name, GAAP, stands for generally accepted accounting principles. These are the principles that guide the creation of the financial statements. Since the discussion today is on two of the four financial reports that make up the financial statements, who would be better qualified to discuss them with you than me? Without further ado, let's begin our discussion of the balance sheet and the statement of cash flows.

The Balance Sheet Recipe

Before we get into the discussion of what makes up the balance sheet, I think that we should discuss some of the basics of the balance sheet. The balance sheet is the financial report that lists all of the accounts of a company along with their balances. This report follows the formula: assets = liabilities + owner's equity. Assets are what a company owns. Liabilities are what a company owes. Owner's equity is how much money company owners have invested in the business.

Balance Sheet Format

All of the financial reports that make up the financial statements have a specific format as determined by GAAP. The title of the statement is always centered and takes three lines. The company name is on the first line. The financial report name is on the second line. And the third line tells the time period that the report covers. The balance sheet uses the last day of the accounting period as the date recorded on the report.

After the heading, the balance sheet is separated into two sides. The left side is to list company assets. The right side is to list both the company liabilities and owner's equity accounts. An easy way to remember this is to remember the balance sheet equation. The equals sign serves as the dividing line between the two sides.

Creating the Balance Sheet

Now it's time to create a basic balance sheet. Let's look at an example. Bill owns a pet shop named Bill's Pet Shop. He has the following accounts:

Assets:

Cash in the bank = $4,500
Inventory = $23,000
Office Supplies = $2,500
Office Equipment = $5,000

Liabilities:

Accounts Payable = $15,000
Notes Payable = $10,000

Owner's Equity:

Bill Campbell - Capital = $10,000

Bill reports his financial information quarterly. The time period for this quarter is January 1 through March 31, 2013.

Following the format that we have listed above, the heading is the first item that needs to be entered. The first line will say 'Bill's Pet Shop.' The second line will say 'balance sheet.' The third line will say 'March 31, 2013.' After the heading is complete, it's time to divide the balance sheet into left and right sides. You don't have to actually draw a line down the center of the report, but you do need to be sure that there is a distinct separation between the asset side of the report and the liabilities and owner's equity side of the report.

Assets, recorded on the left side of the equation, are listed individually along with their balances. Using the information given for the pet shop, those assets will be the cash in the bank, inventory, office supplies, and office equipment. After all the assets are recorded, the total of the assets is calculated and written on the bottom line of the balance sheet. For Bill's Pet Shop, the entry to record total assets will be written as: Total Assets = $35,000.

The liabilities side of the balance sheet follows the same format as the assets. All liabilities are recorded first. For Bill's Pet Shop, the liabilities will be accounts payable and notes payable. Following the last entry for the liabilities, the total liabilities are recorded. For the pet shop, that entry will be written as: Total Liabilities = $25,000.

The owner's equity is reported under the liabilities section. It's important to leave a little space between the liabilities and owner's equity section so that the individual sections are separated. The total owner's equity for the company is reported on the line directly below the owner's equity heading. On the last line of the balance sheet, the total of liabilities and owner's equity is reported. The entry for the pet shop will say: Total Liabilities and Owner's Equity = $35,000. Once you verify that both sides of the balance sheet equal, the balance sheet is complete.

Example of a balance sheet

The Statement of Cash Flows

The statement of cash flows is the last financial report that is included in the financial statements. There are three parts to this financial report.

The first section is the operating activities section. Operating activities are the activities that describe cash that came in or went out of a company as a result of the normal, day-to-day operations of the company.

The second section of the cash flow statement is for listing investing activities. Investing activities describe income that came in or went out of a business as a result of transactions that involved the purchase or sale of items, such as plant, property, or equipment.

The final section of the cash flow statement is the financing activities section. Financing activities describe income that came in or went out of a business as a result of agreements with shareholders and/or investors.

We're still going to use Bill's Pet Shop as our example. On January 1, the company had $5,000 in cash. The following activities occurred:

Cash received from customers was $27,000.
Cash paid for salaries was $6,000.
Cash paid for rent was $3,000.
Cash paid for other items was $12,000.
Purchase of equipment was $5,000.
Additional owner's equity was $5,000.

Now that we have all the information that we need, let's put together the statement of cash flows. As in the other financial reports, the heading of this statement is centered on the page and will take up three lines. The first line is for the company name. In this case, you'd put Bill's Pet Shop. The second line names the financial report. In this case, it'll read: Statement of Cash Flows. The third line lists the time period that the statement covers. For this statement, it will read: For the Quarter ending March 31, 2013.

After the heading section is complete, it's time to enter the correct activities under each section. The first section is the operating section. For Bill's Pet Shop, which of the activities are operating activities? They are cash received from customers, cash paid for salaries, rent, and other items. The cash received from customers is listed first, followed by each of the three cash paid categories. Each item is recorded on a separate line.

After all operating activities are entered, the total income received from operations is calculated. To do this, simply subtract all cash paid from cash received and enter the amount on the next line of the cash flow statement. Bill's Pet Shop has a total cash provided by operating activities of $6,000.

Statement of Cash Flows

The second section of the statement of cash flows is the investing section. For this time period, Bill's Pet Shop only had one item that'll appear here. Bill purchased $5,000 of equipment for the pet shop. This activity meets the criteria for an investment activity. On the statement, the heading investing activities is written below the completed operating activities section. Underneath the heading, the purchase of equipment and the dollar amount is recorded.

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