Create the 3 Financial Statements in 6 steps

Hey, guys, I have a very special video for you today. So what we'll do is we'll create the three financial statements in six easy steps. So if you've been watching the channel, you know that I like to apply steps or a method to every process or every concept that I show you. So today, we'll create the three financial statements. We'll begin with a set of business transactions for a new business. Then we'll go ahead and record the journal entries, and then we'll draft the trial balance, and then we'll use that to create the the three financial statements. And what I want to teach you in this lecture here is two things. The first one is going to be the accounting principles needed to make these recordings. And the second thing is going to be the sequence, because we need to create the three financial statements in this same exact sequence. So if this sounds good to you, let's dive right in. Welcome to another video with your favorite financial controller, Bill Hanna. Before jumping in and creating the financial statements, I wanted to just remind you guys that some of you aren't subscribed to the channel, which is something that doesn't really cost you anything. But it's going to go a long way in debiting my confidence and crediting my imposter syndrome. So please go ahead and do so if you haven't subscribed to the channel. All right, so now diving right into Excel. And by the way, this template is going to be available for free download. Find the link in the description below or where you can go ahead and try your hand at practicing creating these recordings. We have a set of business transactions for a new business. The company opened for business at the start of January 2025. They sell farming supplies to local farmers. Okay, so we have a set of business transactions, and we'll go ahead and create the journal entries. But before diving into journal entries, let me give you a quick running jump into how to create journal entries. So we create journal entries in the form of debits and credits. That's based on the accounting equation. Assets equals liabilities plus owner's equity. We refer to that as the accounting equation. And that is simply saying what we own in the business equals what we owe in the business. So what we own equals what we owe, what we owe liabilities. We owe that to third parties. We owe equities to the owners of the company. Okay, so that is the accounting equation. And we record that in the form of accounts. So transactions of similar nature are grouped together. And that's for example, for assets we have cash, accounts receivable, equipment and so on and so forth. Liabilities, we have accounts payable, loans accrued, expenses, owner's equity. We have common stock, additional paid in capital and retained earnings. Okay, so if we have that, the concept of the accounting equation is assets are always going to have a debit nature, liabilities will have always a credit nature. Same thing for owner's equity. But you might say, hey Bill, there are other accounts outside of assets, liabilities and equities, such as revenues and expenses. Well, that's fine. For revenue, for example, it's going to have a credit nature and that's because it shares the same nature as equity. Equity goes up by credit. Revenue is going to share the same nature because revenue increases equity. The opposite thing is going to happen for expenses. So expenses typically decrease your equity equity. And that's why it's going to have the opposite nature of equity. It's going to have a debit nature. So now that we know what the debits and credits are in terms of nature for the various accounts, we can go ahead and create the journal entries for our business transactions. All right, so our first transaction, the founder invested $300,000 in the company. Okay, great. So now we're going to increase our cash and increase our equity. To increase cash, we're going to debit it. So we're going to say equal to debit 300,000 and we're going to go ahead and credit our owner's equity 300,000 as well. That's the first transaction. The second one, we paid rent for the store for January, $5,000 plus 5K in deposit. Okay, so that's typical. When you pay rent, you at the beginning of the lease you pay a one month deposit. Okay, so for the rent we're going to credit cash because cash went out the door for $5,000. And our debit is to rent expense. So debit rent expense for 5,000 and we said the other 5,000 is a deposit. Now this deposit is refundable at the end of the lease. So we're going to call it deposit receivable and we're going to record it here. So we're going to say debit deposit receivable for 5,000 and credit cash for 5,000. Okay, that's our second transaction. The third transaction is that we bought inventory, which is fertilizer, rakes, watering hoses and various things on credit. So we buy on credit. It means that we will get an invoice and pay it in the future. And that is $50,000. So to record that, we're going to debit our inventory. That's an asset. Right. Equals to $50,000. And we're going to credit what in this case, accounts payable, because now you get an invoice and you will pay it in the future. So we will credit accounts payable for the $50,000. Okay, great. We bought two computers on credit, so that's computers, $4,000. Computers are an asset. So we will create an account for computers and say debit for $4,000 to increase that asset. And we bought it on credit. So we're going to increase our accounts payable by the $4,000. That is a credit. Okay, we're doing great. Let's see, the next one we spent on credit for local TV ads for January, $15,000. Okay, so that's an expense. So we'll go to expense and marketing and say debit 15,000 and credit to accounts payable for the $15,000. Okay, great. The next transaction, we paid utilities $1,000 in cash. So for that we will credit cash for $1,000, and we will debit utilities expense for $1,000. The next one is that we generated revenue for $50,000, and the inventory that we sold was purchased for $25,000. Okay, so that's going to require two journal entries, in this case, the first one to record the revenue. So we will say credit to revenue for 50,000, and our debit is going to be the accounts receivable for the same 50,000. The second entry for this is going to be to record the cost of goods sold. Debit to cost of goods sold for the cost 25,000. So cost of goods sold is right here. Debit for 25,000 and credit to inventory for the same 25,000. Okay, great. The next transaction is going to be that the business paid $15,000 in salaries to the employees and the owner. Okay, so salary expense is pretty straightforward. Debit to salaries for 15,000 and credit to cash for 15,000. So that takes care of the journal entries for our business transactions. And this was our second step in creating the financial statements. Now diving into the third step, which is the triad balance. So the trial balance is an intermediate report between your general journal and your financial statements. And the purpose is to summarize the ending balances of every account that you have. So we have here a listing of all of our accounts, and we need to get the ending balance at the end of the financial period. So we'll go ahead and summarize these balances here. So for cash we say equals to our total debit minus our total of the credit side. Now we'll do the same thing for each of the accounts. We'll say equals inventory, total debit minus total credit. Let me go ahead and do that for all of the accounts here. Foreign. So now that I'm done summarizing all of my accounts in the form of an ending balance, the sum of all of these balances will always equal to zero, which signals to me that my debits equal my credits, which gives me another level of confidence that my entries were correct. Okay, so now that we've done the trial balance, we'll go ahead and do step number four, which is the income statement. Now the income statement will begin with revenue. So revenue equals two and we can just point it to the revenue account here from the trial balance. However, we don't want to display it as a credit, we want to display it as a positive number. So we will put a negative in front of it. Cost of goods sold would say equal to cost of goods sold from our trial balance. And gross profit is going to be revenue minus cost of goods sold. Okay, great. Operating expenses, let's go ahead and pull that from. Our trial balance here is salaries, rent expense and utilities and finally marketing. And then we can go ahead and total our total OPEX for operating expenses and say net income is our gross profit minus total opex. And that will give us a net loss or thousand dollars, which is typical of a startup company. The first financial period we lost $11,000 and we hope that that's going to turn into a profit in the future periods. Let's go ahead and prepare step number five, which is the balance sheet which is needed before we can go ahead and create a statement of cash flows. So for the balance sheet we have our assets, liabilities and owner's equity. But before we do that, and if you enjoy my teaching style, be sure to check out the Controller Academy. I teach the course using a company example so you can see all the steps it takes to create a world class accounting process. I walk you through the setup of billing accounts, payable, equity accounting and payroll. Among many topics. We discuss revenue recognition under ASC606 using real life customer agreements. I also show you how to prepare and analyze the financial statements. If you're interested, head over to the website, check out the detailed curriculum of my CPE courses and let's get back to the video. So we said the balance sheet is going to be made up of assets, liabilities and owner's equity. For assets, we have the typical accounts, cash, inventory, AR deposit receivable and computers. We'll go ahead and grab the ending balance for each one. So for cash, we'll say equal to and bring in the cash balance from the trial balance. Same thing for inventory and all of the other asset accounts. We go ahead and sum our total assets. And now we have total assets. Let's go ahead to liabilities. We only have one liability in this case, which is accounts payable. We'll say equal to and bring in accounts payable balance. Except we don't want it to show a negative. This is a formal financial report. It should be showing in a positive format. So we'll put in a negative in front of it. So that's 69,000 owner's equity. We're going to be doing the same thing equal to and pointed to the owner's equity. And again, that's showing as negative on a trial balance. But you don't want to show that as a negative on a balance sheet. Again, the balance sheet is a formal report that requires a presentation that looks appropriate. And let's bring in the final item, which is our retained earnings or deficit, which is what we close our net income or loss to at the end of the financial period. So notice that we lost 11,000 doll. We're going to bring that in into retained earnings or retained deficit in this case. And then we'll sum our total liabilities on owner's equity. And if you recall, our total assets should always equal to our total liabilities and owner's equity. 358,000 equals 358,000 total liabilities and owner's equity. Great. So now that we're done with the balance sheet, we will jump to the final step, which is the cash flow statement. So the cash flow statement is an indirect method. There are two methods for cash flow statement, direct and indirect. The indirect method, which is what we're going to do here today, takes the net income from your income statement and reconciles that back to cash by adding back or subtracting the changes in working capital, investing activity and financing activity, as we'll see here right now. So the first thing we'll do is bring in our net income or loss in this case minus 11,000, and then we'll add the changes in working capital. So changes in inventory, we'll say equal to bring in the inventory change. Now, we began with zero inventory in this month and we bought 25,000. So we'll bring that in, except it needs to come in in a negative format because that is Cash going out. So whenever you are questioning whether it should be negative or positive, when you bring in a change in working capital, you should always question whether that change is good or bad for the cash balance. Not for the company, but for the cash balance. So 25,000 is an increase in inventory. Is that good or bad for cash? Well, you increase your inventory, that means you spend cash, right? So that's $25,000 that you put in in negative format. Change in AR. When you look at accounts receivable, it went up by $50,000. So you're going to put in here $50,000. But again, is that going to be positive or negative? Well, your accounts receivable went up. Is that good or bad for your cash? If you think about it, right, Accounts receivable going up always means that you didn't collect your cash, and that's bad. You should put that as a negative number. So that equals negative $50,000 change in deposit receivable, $5,000. That is the same idea that we just talked about. An increase in a receivable is going to mean that you did not collect it or you spent the cash. In this case for a deposit, that's negative $5,000 change in accounts payable. If you look at accounts payable, it went up by $69,000. Thinking whether it's positive or negative, when your accounts payable balance goes up, what does that mean? It means that you're building up a payable to a vendor and that means that you're conserving your cash, which is good for cash. So you bring that in as a positive number of $69,000. Now we'll sum the cash from operating activity by saying that that is the sum of all of the transactions and the change in working capital. The next section is going to be cash from investing activity. And that is a computer purchase. So we spent $4,000 on that, and that's going to be negative $4,000 computers because it's negative because we spent the money to get the computers. So we'll put that in as a negative cash from financing activity. We have the seed investment from the owner, and that is going to come in as a positive $300,000 that came in to the business. Now, total cash flow will add the three sections, operating, investing and financing. And we'll say the three added together equals to a flow of $274,000 of cash coming in in the three areas, operating, investing and financing. Now we'll say cash balance at the start of the period that was zero. Our inflow, outflow, which is 274. We'll put that here. And cash at the end of the period, $274,000. And notice. That's how you know you're right. That's going to equal to the cash on the balance sheet, $274,000. I hope that you learned tons from this video. And if you did, go ahead and hit the like button and share the video with someone that you know who would like to learn from this video, and I'll see you in the next one.