{"id":858,"date":"2015-04-24T18:51:13","date_gmt":"2015-04-24T18:51:13","guid":{"rendered":"https:\/\/courses.candelalearning.com\/masterybusiness1xngcxmaster\/?post_type=chapter&#038;p=858"},"modified":"2015-07-12T19:15:18","modified_gmt":"2015-07-12T19:15:18","slug":"reading-understanding-financial-statements","status":"publish","type":"chapter","link":"https:\/\/courses.lumenlearning.com\/wmintrobusinessx51xmaster\/chapter\/reading-understanding-financial-statements\/","title":{"raw":"Reading: Understanding Financial Statements","rendered":"Reading: Understanding Financial Statements"},"content":{"raw":"<div id=\"collins-ch12_s02_n01\" class=\"im_learning_objectives im_editable im_block\">\r\n<h2 class=\"im_title\">The Function of Financial Statements<\/h2>\r\n<p class=\"im_title\">We hope that, so far, we\u00a0have made at least one thing clear: If you\u00a0are in business, you need to understand financial statements. For one thing, the law no longer allows high-ranking executives to plead ignorance or fall back on delegation of authority when it comes to taking responsibility for a firm\u2019s financial reporting.<\/p>\r\n<p class=\"im_title\">In a business environment tainted by episodes of fraudulent financial reporting and other corporate misdeeds, top managers are now being held accountable (so to speak) for the financial statements issued by the people who report to them. For another thing, top managers need to know if the company is hitting on all cylinders or sputtering down the road to bankruptcy. To put it another way (and to switch metaphors): if he did not understand the financial statements issued by the company\u2019s accountants, an executive would be like an airplane pilot who does not know how to read the instrument in the cockpit\u2014he might be able keep the plane in the air for a while, but he would not recognize any signs of impending trouble until it was too late.<\/p>\r\n\r\n<\/div>\r\n<div id=\"collins-ch12_s02_s01\" class=\"im_section\">\r\n\r\nPut yourself in the place of the woman in Figure 1, \"What Connie Wants to Know.\" She runs Connie\u2019s Confections out of her home. She loves what she does, and she feels that she\u2019s doing pretty well. In fact, she has an opportunity to take over a nearby store at very reasonable rent, and she can expand by getting a modest bank loan and investing some more of her own money. So it\u00a0is decision time for Connie: She knows that the survival rate for start-ups isn\u2019t very good, and before taking the next step, she\u00a0would like to get a better idea of whether she\u2019s actually doing well enough to justify the risk. As you can see, she has several pertinent questions. We are not privy to Connie\u2019s finances, but we can tell her how basic financial statements will give her some answers.<span id=\"fwk-collins-fn12_008\" class=\"im_footnote\">We will discuss the <em class=\"im_emphasis\">statement of cash flows<\/em> later on.<\/span>\r\n<div id=\"collins-ch12_s02_s01_f10\" class=\"im_figure im_large im_editable im_block\">\r\n\r\n[caption id=\"\" align=\"aligncenter\" width=\"594\"]<a href=\"https:\/\/textimgs.s3.amazonaws.com\/introbus\/section_16\/870be888c8d04e62fff9cd5e0c7039a4.jpg\" target=\"_blank\"><img src=\"https:\/\/courses.candelalearning.com\/introbusiness2xmaster\/wp-content\/uploads\/sites\/182\/2014\/08\/sm_870be888c8d04e62fff9cd5e0c7039a4.jpg\" alt=\"To answer questions like, What were my sales this year? How much were my expenses this year? How much profit did I make this year? check the income statement. It shows what Connie\u2019s sales and expenses are and whether she made a profit. To answer questions like, What are my total assets at the end of this year? How much debt did I accumulate this year? How much did I spend on supplies this year? check the balance sheet. It shows what assets and liabilities Connie has and the amount that she\u2019s invested in her business. To answer questions like, How much money did I put into the company this year? How much of my profits did I put back in the company this year? check the statement of owner\u2019s equity. It shows changes in Connie\u2019s owner\u2019s equity over a specific period of time. To answer questions like, How much cash has the company brought in this year? When cash went out this year, how much of it went where? check statement of cash flows. It shows how much cash Connie has coming in and going out.\" width=\"594\" height=\"463\" \/><\/a> Figure 1.\u00a0What Connie Wants to Know[\/caption]\r\n\r\n<\/div>\r\n<div id=\"collins-ch12_s02_s01_s01\" class=\"im_section\">\r\n<h2 class=\"im_title im_editable im_block\">Toying with a Business Idea<\/h2>\r\nWe know what you\u2019re thinking: It\u00a0is nice to know that accounting deals with real-life situations, but while you wish Connie the best, you do not know enough about the confectionary business to appreciate either the business decisions or the financial details. Is there any way to bring this lesson a little closer to home? Besides, while knowing what financial statements will tell you is one thing, you want to know how to <em class=\"im_emphasis\">prepare<\/em> them.\r\n\r\nAgreed. So let\u00a0us assume that you need to earn money while you\u2019re in college and that you\u2019ve decided to start a small business. Your business will involve selling stuff to other college students, and to keep things simple, we\u2019ll assume that you\u2019re going to operate on a \u201ccash\u201d basis: you\u2019ll pay for everything with cash, and everyone who buys something from you will pay in cash.\r\n\r\n<em class=\"im_emphasis\">A Word about Cash.<\/em> You probably have at least a little <em class=\"im_emphasis\">cash<\/em> on you right now\u2014some currency, or paper money, and coins. In accounting, however, the term <em class=\"im_emphasis\">cash<\/em> refers to more than just paper money and coins. It also refers to the money that you have in checking and savings accounts and includes items that you can deposit in these accounts, such as money orders and different types of checks.\r\n\r\nYour first task is to decide exactly what you\u2019re going to sell. You\u00a0have noticed that with homework, exams, social commitments, and the hectic lifestyle of the average college student, you and most of the people you know always seem to be under a lot of stress. Sometimes you wish you could just lie back between meals and bounce a ball off the wall. And that\u2019s when the idea hits you: Maybe you could make some money by selling a product called the \u201cStress-Buster Play Pack.\u201d Here\u2019s what you have in mind: you\u2019ll buy small toys and other fun stuff\u2014instant stress relievers\u2014at a local dollar store and pack them in a rainbow-colored plastic treasure chest labeled \u201cStress-Buster.\u201d\r\n\r\nAnd here\u2019s where you stand: You have enough cash to buy a month\u2019s worth of plastic treasure chests and toys. After that, you\u2019ll use the cash generated from sales of Stress-Buster Play Packs to replenish your supply. Each plastic chest will cost $1.00, and you\u2019ll fill each one with a variety of five of the following toys, all of which you can buy for $1.00 each:\r\n<ul id=\"collins-5300-20111123-080037-761756\" class=\"im_itemizedlist im_editable im_block\">\r\n\t<li>A happy face stress ball<\/li>\r\n\t<li>A roomarang (an indoor boomerang)<\/li>\r\n\t<li>Some silly putty<\/li>\r\n\t<li>An inflatable beach ball<\/li>\r\n\t<li>A coil \u201cslinky\u201d spring<\/li>\r\n\t<li>A paddle-ball game<\/li>\r\n\t<li>A ball for bouncing off walls<\/li>\r\n<\/ul>\r\nYou plan to sell each Stress-Buster Play Pack for $10 from a rented table stationed outside a major dining hall. Renting the table will cost you $20 a month. Because your own grades aren\u2019t what your parents and the dean would like them to be, you decide to hire fellow students (trustworthy people with better grades than yours) to staff the table at peak traffic periods. They\u2019ll be on duty from noon until 2:00 p.m. each weekday, and you\u2019ll pay them $6 an hour. Wages, therefore, will cost you $240 a month (2 hours \u00d7 5 days \u00d7 4 weeks = 40 hours \u00d7 $6). Finally, you\u2019ll run ads in the college newspaper at a monthly cost of $40. Thus your total monthly costs will amount to $300 ($20 + $240 + $40).\r\n\r\n<\/div>\r\n<\/div>\r\n<div id=\"collins-ch12_s02_s02\" class=\"im_section\">\r\n<h2 class=\"im_title im_editable im_block\">The Income Statement<\/h2>\r\nLet\u2019s say that during your first month, you sell one hundred play packs. Not bad, you say to yourself, but did I make a <em class=\"im_emphasis\">profit<\/em>? To find out, you prepare an <span class=\"im_margin_term\"><span class=\"im_glossterm\">income statement<\/span><\/span> showing <span class=\"im_margin_term\"><span class=\"im_glossterm\">revenues<\/span><\/span>, or <strong class=\"im_emphasis im_bold\">sales<\/strong>, and <span class=\"im_margin_term\"><span class=\"im_glossterm\">expenses<\/span><\/span>\u2014the costs of doing business. You divide your expenses into the following two categories:\r\n<ul id=\"collins-5300-20111123-081006-080304\" class=\"im_itemizedlist im_editable im_block\">\r\n\t<li><span class=\"im_margin_term\"><span class=\"im_glossterm\">Cost of goods sold<\/span><\/span>: the total cost of the <em class=\"im_emphasis\">goods that you\u2019ve sold<\/em><\/li>\r\n\t<li><span class=\"im_margin_term\"><span class=\"im_glossterm\">Operating expenses<\/span><\/span>: the costs of <em class=\"im_emphasis\">operating your business<\/em> except for the costs of things that you\u2019ve sold<\/li>\r\n<\/ul>\r\nNow you need to do a little subtracting, as follows:\r\n<ol id=\"collins-5300-20111123-081819-852034\" class=\"im_orderedlist im_editable im_block\">\r\n\t<li>The positive difference between <em class=\"im_emphasis\">sales<\/em> and <em class=\"im_emphasis\">cost of goods sold<\/em> is your <span class=\"im_margin_term\"><span class=\"im_glossterm\">gross profit or gross margin<\/span><\/span>.<\/li>\r\n\t<li>The positive difference between <em class=\"im_emphasis\">gross profit<\/em> and <em class=\"im_emphasis\">operating expenses<\/em> is your <span class=\"im_margin_term\"><span class=\"im_glossterm\">net income<\/span><\/span> or <strong class=\"im_emphasis im_bold\">profit<\/strong>, which is the proverbial \u201cbottom line.\u201d (If this difference is <em class=\"im_emphasis\">negative<\/em>, you took a <em class=\"im_emphasis\">loss<\/em> instead of making a profit.)<\/li>\r\n<\/ol>\r\nFigure 2, \"Income Statement for Stress-Buster Company,\" is your income statement for the first month. (Remember that we\u2019ve made things simpler by handling everything in cash.)\r\n<div id=\"collins-ch12_s02_s02_f01\" class=\"im_figure im_large im_editable im_block\">\r\n\r\n[caption id=\"\" align=\"aligncenter\" width=\"500\"]<a href=\"https:\/\/textimgs.s3.amazonaws.com\/introbus\/section_16\/a83af320f4e111497131740d8e877142.jpg\" target=\"_blank\"><img src=\"https:\/\/courses.candelalearning.com\/introbusiness2xmaster\/wp-content\/uploads\/sites\/182\/2014\/08\/sm_a83af320f4e111497131740d8e877142.jpg\" alt=\"Income statement. Sales of 100 times 10 dollars equals 1,000. Less costs of goods sold of 100 times 6 dollars equals 600. Gross profit of 100 times 4 dollars is 400. 1 thousand minus 600 is 400. Less operating expenses. Salaries, 240. Advertising, 40. Table rental, 20. 240 plus 40 plus 20 equals 300. 400 minus 300 equals net income\/profit of 100 dollars.\" width=\"500\" height=\"322\" \/><\/a> Figure 2.\u00a0Income Statement for Stress-Buster Company[\/caption]\r\n\r\n<\/div>\r\n<div id=\"collins-ch12_s02_s02_s02\" class=\"im_section\">\r\n<h2 class=\"im_title im_editable im_block\">Did You Make Any Money?<\/h2>\r\nWhat does your income statement tell you? It has provided you with the following four pieces of valuable information:\r\n<ol>\r\n\t<li>You sold 100 units at $10 each, bringing in <em class=\"im_emphasis\">revenues<\/em> or <em class=\"im_emphasis\">sales<\/em> of $1,000.<\/li>\r\n\t<li>Each unit that you sold cost you $6\u2014$1 for the treasure chest plus 5 toys costing $1 each. So your <em class=\"im_emphasis\">cost of goods sold<\/em> is $600 (100 units \u00d7 $6 per unit).<\/li>\r\n\t<li>Your <em class=\"im_emphasis\">gross profit<\/em>\u2014the amount left after subtracting cost of goods sold from sales\u2014is $400 (100 units \u00d7 $4 each).<\/li>\r\n\t<li>After subtracting <em class=\"im_emphasis\">operating expenses<\/em> of $300\u2014the costs of doing business other than the cost of products sold\u2014you generated a positive <em class=\"im_emphasis\">net income<\/em> or <em class=\"im_emphasis\">profit<\/em> of $100.<strong class=\"im_emphasis im_bold\">\r\n<\/strong><\/li>\r\n<\/ol>\r\n<\/div>\r\n<div id=\"collins-ch12_s02_s02_s03\" class=\"im_section\">\r\n<h2 class=\"im_title im_editable im_block\">What If You Want to Make More Money?<\/h2>\r\nYou\u2019re quite relieved to see that you made a profit during your first month, but you can\u2019t help but wonder what you\u2019ll have to do to make even more money next month. You consider the following three possibilities:\r\n\r\n<\/div>\r\n<ol id=\"collins-ch12_s02_s02_l01\" class=\"im_orderedlist im_editable im_block\">\r\n\t<li>Reduce your cost of goods sold (say, package four toys instead of five)<\/li>\r\n\t<li>Reduce your operating costs (salaries, advertising, table rental)<\/li>\r\n\t<li>Increase the quantity of units sold<\/li>\r\n<\/ol>\r\nIn order to consider these possibilities fully, you need to generate new income statements for each option. And to do that, you\u2019ll have to play a few \u201cwhat-if\u201d games. Because possibility #1\u2014packaging four toys instead of five\u2014is the most appealing, you start there. Your cost of goods sold would go down from $6 to $5 per unit (4 toys at $1 each + 1 plastic treasure chest at $1). Figure 3, \"Proposed Income Statement Number One for Stress-Buster Company,\" below, is your hypothetical income statement if you choose this option.\r\n<div id=\"collins-ch12_s02_s02_f02\" class=\"im_figure im_large im_editable im_block\">\r\n\r\n[caption id=\"\" align=\"aligncenter\" width=\"500\"]<a href=\"https:\/\/textimgs.s3.amazonaws.com\/introbus\/section_16\/f0512f21741e847e3be2eca2bc06f532.jpg\" target=\"_blank\"><img src=\"https:\/\/courses.candelalearning.com\/introbusiness2xmaster\/wp-content\/uploads\/sites\/182\/2014\/08\/sm_f0512f21741e847e3be2eca2bc06f532.jpg\" alt=\"Income statement if cost of goods sold is $5 per unit. Sales of 100 times 10 dollars equals 1,000. Less costs of goods sold of 100 times 5 dollars equals 500. Gross profit of 100 times 5 dollars is 500. 1 thousand minus 500 is 500. Less operating expenses. Salaries, 240. Advertising, 40. Table rental, 20. 240 plus 40 plus 20 equals 300. 500 minus 300 equals net income\/profit of 200 dollars.\" width=\"500\" height=\"344\" \/><\/a> Figure 3.\u00a0Proposed Income Statement Number One for Stress-Buster Company[\/caption]\r\n\r\n<\/div>\r\nPossibility #1 seems to be a good idea. Under this scenario, your income doubles from $100 to $200 because your per-unit <em class=\"im_emphasis\">gross profit<\/em> increases by $1 (and you sold 100 stress packs). But there may be a catch: If you cut back on the number of toys, your customers might perceive your product as a lesser value for the money. In fact, you\u2019re reminded of a conversation that you once had with a friend whose father, a restaurant owner, had cut back on the cost of the food he served by buying less expensive meat. In the short term, gross profit per meal went up, but customers eventually stopped coming back and the restaurant nearly went out of business.\r\n\r\nThus you decide to consider possibility #2\u2014reducing your operating costs. In theory, it\u2019s a good idea, but in practice\u2014at least in your case\u2014it probably won\u2019t work. Why not? For one thing, you can\u2019t do without the table and you need your workers (because your grades haven\u2019t improved, you still don\u2019t have time to sit at the table yourself). Second, if you cut salaries from, say, $6 to $5 an hour, you may have a hard time finding people willing to work for you. Finally, you could reduce advertising costs by running an ad every two weeks instead of every week, but this tactic would increase your income by only $20 a month and could easily lead to a drop in sales.\r\n\r\nNow you move on to possibility #3\u2014increase sales. The appealing thing about this option is that it has no downside. If you could somehow increase the number of units sold from 100 Stress-Buster packs per month to 150, your income would go up, even if you stick with your original five-toy product. So you decide to crunch some numbers for possibility #3 and come up with the new \u201cwhat-if\u201d income statement, below, Figure 4,\u00a0\"Proposed Income Statement Number Two for Stress-Buster Company\":\r\n<div id=\"collins-ch12_s02_s02_f03\" class=\"im_figure im_large im_editable im_block\">\r\n\r\n[caption id=\"\" align=\"aligncenter\" width=\"500\"]<a href=\"https:\/\/textimgs.s3.amazonaws.com\/introbus\/section_16\/578d8a6e1acfbbdf9f6129ce29244d4f.jpg\" target=\"_blank\"><img src=\"https:\/\/courses.candelalearning.com\/introbusiness2xmaster\/wp-content\/uploads\/sites\/182\/2014\/08\/sm_578d8a6e1acfbbdf9f6129ce29244d4f.jpg\" alt=\"Income statement if sales increase to 150 units. Sales of 150 times 10 dollars equals 1,500. Less costs of goods sold of 150 times 6 dollars equals 900. Gross profit of 150 times 4 dollars is 600. 1,500 minus 900 is 600. Less operating expenses. Salaries, 240. Advertising, 40. Table rental, 20. 240 plus 40 plus 20 equals 300. 600 minus 300 equals net income\/profit of 300 dollars.\" width=\"500\" height=\"339\" \/><\/a> Figure 4.\u00a0Proposed Income Statement Number Two for Stress-Buster Company[\/caption]\r\n\r\n<\/div>\r\nAs you can see, this is an attractive possibility, even though you haven\u2019t figured out how you\u2019re going to increase sales (maybe you could put up some eye-popping posters and play cool music to attract people to your table. Or maybe your workers could attract buyers by demonstrating relaxation and stress-reduction exercises).\r\n<div id=\"collins-ch12_s02_s02_s01\" class=\"im_section\">\r\n<h2 class=\"im_title im_editable im_block\">Break-Even Analysis<\/h2>\r\nPlaying these what-if games has started you thinking: is there some way to figure out the level of sales you need to avoid <em class=\"im_emphasis\">losing<\/em> money\u2014to \u201cbreak even\u201d? This can be done using <span class=\"im_margin_term\"><span class=\"im_glossterm\">break-even analysis<\/span><\/span>. To break even (have no profit or loss), your <em class=\"im_emphasis\">total sales revenue must exactly equal all your expenses (both variable and fixed)<\/em>. For a merchandiser, like a hypothetical one called The College Shop, this balance will occur when gross profit equals all other (fixed) costs. To determine the level of sales at which this will occur, you need to do the following:\r\n<ol id=\"collins-ch12_s02_s02_s01_l01\" class=\"im_orderedlist im_editable im_block\">\r\n\t<li>Determine your total <span class=\"im_margin_term\"><span class=\"im_glossterm\">fixed costs<\/span><\/span>, which are so called because the total cost doesn\u2019t change as the quantity of goods sold changes):\r\n<ul id=\"collins-ch12_s02_s02_s01_l02\" class=\"im_itemizedlist\">\r\n\t<li>Fixed costs = $240 salaries + $40 advertising + $20 table = $300<\/li>\r\n<\/ul>\r\n<\/li>\r\n\t<li>Identify your <span class=\"im_margin_term\"><span class=\"im_glossterm\">variable costs<\/span><\/span>. These are costs that vary, in total, as the quantity of goods sold changes but stay constant on a per-unit basis. State variable costs on a per-unit basis:\r\n<ul id=\"collins-ch12_s02_s02_s01_l03\" class=\"im_itemizedlist\">\r\n\t<li>Variable cost per unit = $6 ($1 for the treasure chest and $5 for the toys)<\/li>\r\n<\/ul>\r\n<\/li>\r\n\t<li>Determine your <span class=\"im_margin_term\"><span class=\"im_glossterm\">contribution margin per unit<\/span><\/span>: selling price per unit \u2013 variable cost per unit:\r\n<ul id=\"collins-ch12_s02_s02_s01_l04\" class=\"im_itemizedlist\">\r\n\t<li>Contribution margin per unit = $10 selling price \u2013 $6 variable cost per unit = $4<\/li>\r\n<\/ul>\r\n<\/li>\r\n\t<li>Calculate your <span class=\"im_margin_term\"><span class=\"im_glossterm\">break-even point in units<\/span><\/span>: fixed costs \u00f7 contribution margin per unit:\r\n<ul id=\"collins-ch12_s02_s02_s01_l05\" class=\"im_itemizedlist\">\r\n\t<li>Breakeven in units = $300 fixed costs \u00f7 $4 contribution margin per unit = 75 units<\/li>\r\n<\/ul>\r\n<\/li>\r\n<\/ol>\r\nYour calculation means that if you sell 75 units, you\u2019ll end up with zero profit (or loss) and will exactly break even. To test your calculation, you can prepare a what-if income statement for 75 units in sales (which is your break-even number of sales). The resulting statement is shown below in Figure 5, \"Proposed Income Statement Number Three for Stress-Buster Company\":\r\n<div id=\"collins-ch12_s02_s02_s01_f01\" class=\"im_figure im_large im_editable im_block\">\r\n\r\n[caption id=\"\" align=\"aligncenter\" width=\"500\"]<a href=\"https:\/\/textimgs.s3.amazonaws.com\/introbus\/section_16\/2d1baf8a24cdf09f66e0f4b3ce39eda3.jpg\" target=\"_blank\"><img src=\"https:\/\/courses.candelalearning.com\/introbusiness2xmaster\/wp-content\/uploads\/sites\/182\/2014\/08\/sm_2d1baf8a24cdf09f66e0f4b3ce39eda3.jpg\" alt=\"Income statement at break-even level of sales equals 75 units. Sales of 75 times 10 dollars equals 750. Less costs of goods sold of 75 times 6 dollars equals 450. Gross profit of 75 times 4 dollars is 300. 750 minus 450 is 300. Less operating expenses. Salaries, 240. Advertising, 40. Table rental, 20. 240 plus 40 plus 20 equals 300. 300 minus 300 equals net income\/profit of zero dollars.\" width=\"500\" height=\"340\" \/><\/a> Figure 5.\u00a0Proposed Income Statement Number Three for Stress-Buster Company[\/caption]\r\n\r\n<\/div>\r\nWhat if you want to do better than just break even? What if you want to earn a profit of $200 next month? How many Stress-Buster Pack units would you need to sell? You can find out by building on the results of your break-even analysis. Note that each additional sale will bring in $4 (contribution margin per unit). If you want to make a profit of $200\u2014which is $200 <em class=\"im_emphasis\">above your break-even point<\/em>\u2014you must sell an additional 50 units ($200 desired profit divided by $4 contribution margin per unit) above your break-even point of 75 units. If you sell 125 units (75 break-even units + the additional 50), you\u2019ll make a profit of $200 a month.\r\n\r\nAs you can see, break-even analysis is rather handy. It enables you to determine the level of sales that you must reach to avoid losing money and the level of sales that you have to reach to earn a profit of $200. Such information will help you plan for your business. For example, knowing you must sell 125 Stress-Buster Packs to earn a $200 profit will help you decide how much time and money you need to devote to marketing your product.\r\n\r\n<\/div>\r\n<\/div>\r\n<div id=\"collins-ch12_s02_s03\" class=\"im_section\">\r\n<h2 class=\"im_title im_editable im_block\">The Balance Sheet<\/h2>\r\nYour <span class=\"im_margin_term\"><span class=\"im_glossterm\">balance sheet<\/span><\/span> reports the following information:\r\n<ul id=\"collins-ch12_s02_s03_l01\" class=\"im_itemizedlist im_editable im_block\">\r\n\t<li>Your <span class=\"im_margin_term\"><span class=\"im_glossterm\">assets<\/span><\/span>: the resources from which it expects to gain some future benefit<\/li>\r\n\t<li>Your <span class=\"im_margin_term\"><span class=\"im_glossterm\">liabilities<\/span><\/span>: the debts that it owes to <em class=\"im_emphasis\">outside<\/em> individuals or organizations<\/li>\r\n\t<li>Your <span class=\"im_margin_term\"><span class=\"im_glossterm\">owner\u2019s equity<\/span><\/span>: your investment in your business<\/li>\r\n<\/ul>\r\nWhereas your income statement tells you how much income you earned <em class=\"im_emphasis\">over some period of time<\/em>, your balance sheet tells you what you have (and where it came from) <em class=\"im_emphasis\">at a specific point in time<\/em>.\r\n\r\nMost companies prepare financial statements on a twelve-month basis\u2014that is, for a <span class=\"im_margin_term\"><span class=\"im_glossterm\">fiscal year<\/span><\/span> which ends on December 31 or some other logical date, such as June 30 or September 30. Why do fiscal years vary? A company generally picks a fiscal-year end date that coincides with the end of its peak selling period; thus a crabmeat processor might end its fiscal year in October, when the crab supply has dwindled. Most companies also produce financial statements on a quarterly or monthly basis. For Stress-Buster, you\u2019ll want to prepare a monthly balance sheet.\r\n<div id=\"collins-ch12_s02_s03_s01\" class=\"im_section\">\r\n<h2 class=\"im_title im_editable im_block\">The Accounting Equation<\/h2>\r\nThe balance sheet is based on the <span class=\"im_margin_term\"><span class=\"im_glossterm\">accounting equation, as follows<\/span><\/span>:<span class=\"im_informalequation im_block\">\r\n<span class=\"im_mathphrase\">assets = liabilities + owner\u2019s equity<\/span>\r\n<\/span>\r\n\r\nThis important equation highlights the fact that a company\u2019s <em class=\"im_emphasis\">assets<\/em> came from somewhere: either from loans (<em class=\"im_emphasis\">liabilities<\/em>) or from investments made by the owners (<em class=\"im_emphasis\">owner\u2019s equity<\/em>). This means that the asset section of the balance sheet on the one hand and the liability and owner\u2019s-equity section on the other must be equal, or <em class=\"im_emphasis\">balance<\/em>. Thus the term <em class=\"im_emphasis\">balance sheet<\/em>.\r\n\r\nLet\u2019s prepare two balance sheets for your company: one for the first day you started and one for the end of your first month of business. We\u2019ll assume that when you started Stress-Buster, you borrowed $400 from your parents and put in $200 of your own money. If you look at your first balance sheet, below, in Figure 6, \"Balance Sheet Number One for Stress-Buster Company,\" you\u2019ll see that your business has $600 in cash (your <em class=\"im_emphasis\">assets<\/em>): Of this total, you borrowed $400 (your <em class=\"im_emphasis\">liabilities<\/em>) and invested $200 of your own money (your <em class=\"im_emphasis\">owner\u2019s equity<\/em>). So far, so good: Your assets section <em class=\"im_emphasis\">balances<\/em> with your liabilities and owner\u2019s equity section.\r\n<div id=\"collins-ch12_s02_s03_s01_f01\" class=\"im_figure im_large im_editable im_block\">\r\n\r\n[caption id=\"\" align=\"aligncenter\" width=\"500\"]<a href=\"https:\/\/textimgs.s3.amazonaws.com\/introbus\/section_16\/ad541ca3dedf5ae31cdd2d2388fd0300.jpg\" target=\"_blank\"><img class=\"\" src=\"https:\/\/courses.candelalearning.com\/introbusiness2xmaster\/wp-content\/uploads\/sites\/182\/2014\/08\/sm_ad541ca3dedf5ae31cdd2d2388fd0300.jpg\" alt=\"Balance Sheet. Assets: cash, 600 dollars. Liabilities and owner's equity. Liabilities, 400. Owner's equity, 200. Total liabilities and owner's equity is 600 dollars.\" width=\"500\" height=\"271\" \/><\/a> Figure 6.\u00a0Balance Sheet Number One for Stress-Buster Company[\/caption]\r\n\r\n<\/div>\r\nNow let\u2019s see how things have changed by the end of the month. Recall that Stress-Buster earned $100 (based on sales of 100 units) during the month of September and that you decided to leave these earnings in the business. This $100 profit increases two items on your <em class=\"im_emphasis\">balance sheet<\/em>: the <em class=\"im_emphasis\">assets<\/em> of the company (its cash) and your investment in it (its <em class=\"im_emphasis\">owner\u2019s equity<\/em>). Below, Figure 7,\u00a0\"Balance Sheet Number Two for Stress-Buster Company,\" shows what your balance sheet will look like on September 30. Once again, it <em class=\"im_emphasis\">balances<\/em>. You now have $700 in cash: $400 that you borrowed plus $300 that you\u2019ve invested in the business (your original $200 investment plus the $100 profit from the first month of operations, which you\u2019ve kept in the business).\r\n<div id=\"collins-ch12_s02_s03_s01_f02\" class=\"im_figure im_large im_editable im_block\">\r\n\r\n[caption id=\"\" align=\"aligncenter\" width=\"500\"]<a href=\"https:\/\/textimgs.s3.amazonaws.com\/introbus\/section_16\/3f3290aee0cf88bb730eb9556484cf55.jpg\" target=\"_blank\"><img src=\"https:\/\/courses.candelalearning.com\/introbusiness2xmaster\/wp-content\/uploads\/sites\/182\/2014\/08\/sm_3f3290aee0cf88bb730eb9556484cf55.jpg\" alt=\"Balance Sheet. Assets: cash, (original 600 dollars plus 100 dollars earned) equals 700 dollars. Liabilities and owner's equity. Liabilities, 400. Owner's equity, 200 dollars invested by owner plus 100 dollar profits retained) equals 300 dollars. Total liabilities and owner's equity is 700 dollars.\" width=\"500\" height=\"304\" \/><\/a> Figure 7.\u00a0Balance Sheet Number Two for Stress-Buster Company[\/caption]\r\n\r\n<\/div>\r\n<\/div>\r\n<\/div>\r\n<div id=\"collins-ch12_s02_s04\" class=\"im_section\">\r\n<h2 class=\"im_title im_editable im_block\">The Statement of Owner\u2019s Equity<\/h2>\r\nNote that we used the <em class=\"im_emphasis\">net income<\/em> figure from your <em class=\"im_emphasis\">income statement<\/em> to update the owner\u2019s equity section of your end-of-month balance sheet. Often, companies prepare an additional financial statement, called the <span class=\"im_margin_term\"><span class=\"im_glossterm\">statement of owner\u2019s equity<\/span><\/span>, which details changes in owner\u2019s equity for the reporting period. Figure 8, \"Sample Statement of Owner\u2019s Equity for Stress-Buster Company,\" shows what this statement looks like.\r\n<div id=\"collins-ch12_s03_f99\" class=\"im_figure im_large im_editable im_block\">\r\n\r\n[caption id=\"\" align=\"aligncenter\" width=\"500\"]<a href=\"https:\/\/textimgs.s3.amazonaws.com\/introbus\/section_16\/007821ed2cb6dac773edc41bfbe38876.jpg\" target=\"_blank\"><img src=\"https:\/\/courses.candelalearning.com\/introbusiness2xmaster\/wp-content\/uploads\/sites\/182\/2014\/08\/sm_007821ed2cb6dac773edc41bfbe38876.jpg\" alt=\"Statement of Owner's Equity. 200 dollars plus net income 100 dollars. Owner's equity is 300 dollars.\" width=\"500\" height=\"220\" \/><\/a> Figure 8. Sample Statement of Owner\u2019s Equity for Stress-Buster Company[\/caption]\r\n\r\n<\/div>\r\n<\/div>\r\n<div id=\"collins-ch12_s02_s05\" class=\"im_section\">\r\n<h2 class=\"im_title im_editable im_block\">How Do Financial Statements Relate to One Another?<\/h2>\r\nWhen you prepare your financial statements, you should complete them in the following\u00a0order:\r\n<ol id=\"collins-5300-20111123-092319-468167\" class=\"im_orderedlist im_editable im_block\">\r\n\t<li>Income statement<\/li>\r\n\t<li>Statement of owner\u2019s equity<\/li>\r\n\t<li>Balance sheet<\/li>\r\n<\/ol>\r\nWhy must they be prepared in this order? Because financial statements are interrelated: Numbers generated on one financial statement appear on other financial statements. Figure 9, \"How Financial Statements Relate to One Another,\" presents Stress-Buster\u2019s financial statements for the month ended September 30, 20X1. As you review these statements, note that in two cases, numbers from one statement appear in another statement:\r\n\r\n[caption id=\"attachment_3736\" align=\"aligncenter\" width=\"500\"]<a href=\"https:\/\/courses.lumenlearning.com\/wmintrobusinessx51xmaster\/wp-content\/uploads\/sites\/135\/2015\/06\/How-Financial-Statements-Relate.jpg\"><img class=\"wp-image-3736 \" src=\"https:\/\/courses.lumenlearning.com\/wmintrobusinessx51xmaster\/wp-content\/uploads\/sites\/135\/2015\/06\/How-Financial-Statements-Relate-440x1024.jpg\" alt=\"The net income for the month on the income statement is also on the statement of owner\u2019s equity as an addition to the beginning Owner\u2019s equity balance. This addition of $100 increases the balance in owner\u2019s equity from $200 to $300. The ending owner\u2019s equity balance of $300 also appears on the balance sheet as owner\u2019s equity.\" width=\"500\" height=\"1164\" \/><\/a> Figure 9.\u00a0How Financial Statements Relate to One Another[\/caption]\r\n\r\n<div id=\"collins-ch12_s02_s03_s01_f99\" class=\"im_figure im_full im_editable im_block\"><\/div>\r\nIf the interlinking numbers are carried forward correctly, and if assets and liabilities are listed correctly, then the balance sheet will <em class=\"im_emphasis\">balance<\/em>: Total <em class=\"im_emphasis\">assets<\/em> will equal the total of <em class=\"im_emphasis\">liabilities<\/em> plus <em class=\"im_emphasis\">owner\u2019s equity<\/em>.\r\n<div id=\"collins-ch12_s02_s03_s01_n01\" class=\"im_key_takeaways im_block\">\r\n<div class=\"keytakeaways\">\r\n\t<h3>KEY TAKEAWAYS<\/h3>\r\n<ul id=\"collins-ch12_s02_s03_s01_l01\" class=\"im_itemizedlist\">\r\n\t<li>Accountants prepare four <strong class=\"im_emphasis im_bold\">financial statements<\/strong>: <em class=\"im_emphasis\">income statement<\/em>, <em class=\"im_emphasis\">statement of owner\u2019s equity<\/em>, <em class=\"im_emphasis\">balance sheet<\/em>, and <em class=\"im_emphasis\">statement of cash flows<\/em> (which is discussed later in the chapter).<\/li>\r\n\t<li>The <strong class=\"im_emphasis im_bold\">income statement<\/strong> shows a firm\u2019s <strong class=\"im_emphasis im_bold\">revenues<\/strong> and <strong class=\"im_emphasis im_bold\">expenses<\/strong> and whether it made a profit.<\/li>\r\n\t<li>The <strong class=\"im_emphasis im_bold\">balance sheet<\/strong> shows a firm\u2019s <strong class=\"im_emphasis im_bold\">assets<\/strong>, <strong class=\"im_emphasis im_bold\">liabilities<\/strong> and<strong class=\"im_emphasis im_bold\"> owner\u2019s equity<\/strong> (the amount that its owners have invested in it).<\/li>\r\n\t<li>The balance sheet is based on the <strong class=\"im_emphasis im_bold\">accounting equation<\/strong>:<span class=\"im_informalequation\">\r\n<span class=\"im_mathphrase\">assets = liabilities + owner\u2019s equity<\/span>\r\n<\/span>This equation highlights the fact that a company\u2019s <em class=\"im_emphasis\">assets<\/em> came from one of two sources: either from loans (its <em class=\"im_emphasis\">liabilities<\/em>) or from investments made by owners (its <em class=\"im_emphasis\">owner\u2019s equity<\/em>).<\/li>\r\n\t<li>The <strong class=\"im_emphasis im_bold\">statement of owner\u2019s equity<\/strong> reports the changes in owner\u2019s equity that have occurred over a specified period of time.<\/li>\r\n\t<li>Financial statements should be competed in a certain order: <em class=\"im_emphasis\">income statement<\/em>, <em class=\"im_emphasis\">statement of owner\u2019s equity<\/em>, and <em class=\"im_emphasis\">balance sheet<\/em>. These financial statements are interrelated because numbers generated on one financial statement appear on other financial statements.<\/li>\r\n\t<li><strong class=\"im_emphasis im_bold\">Break-even analysis<\/strong> is a technique used to determine the level of sales needed to break even\u2014to operate at a sales level at which you have neither profit nor loss.<\/li>\r\n\t<li>To break even, total sales revenue must exactly equal all your expenses (both <strong class=\"im_emphasis im_bold\">variable<\/strong> and <strong class=\"im_emphasis im_bold\">fixed costs<\/strong>).<\/li>\r\n\t<li>To calculate the <strong class=\"im_emphasis im_bold\">break-even point in units<\/strong> to be sold, you divide fixed costs by <strong class=\"im_emphasis im_bold\">contribution margin per unit<\/strong> (selling price per unit minus variable cost per unit).<\/li>\r\n\t<li>This technique can also be used to determine the level of sales needed to obtain a specified profit.<\/li>\r\n<\/ul><\/div>\r\n<\/div>\r\n<\/div>","rendered":"<div id=\"collins-ch12_s02_n01\" class=\"im_learning_objectives im_editable im_block\">\n<h2 class=\"im_title\">The Function of Financial Statements<\/h2>\n<p class=\"im_title\">We hope that, so far, we\u00a0have made at least one thing clear: If you\u00a0are in business, you need to understand financial statements. For one thing, the law no longer allows high-ranking executives to plead ignorance or fall back on delegation of authority when it comes to taking responsibility for a firm\u2019s financial reporting.<\/p>\n<p class=\"im_title\">In a business environment tainted by episodes of fraudulent financial reporting and other corporate misdeeds, top managers are now being held accountable (so to speak) for the financial statements issued by the people who report to them. For another thing, top managers need to know if the company is hitting on all cylinders or sputtering down the road to bankruptcy. To put it another way (and to switch metaphors): if he did not understand the financial statements issued by the company\u2019s accountants, an executive would be like an airplane pilot who does not know how to read the instrument in the cockpit\u2014he might be able keep the plane in the air for a while, but he would not recognize any signs of impending trouble until it was too late.<\/p>\n<\/div>\n<div id=\"collins-ch12_s02_s01\" class=\"im_section\">\n<p>Put yourself in the place of the woman in Figure 1, &#8220;What Connie Wants to Know.&#8221; She runs Connie\u2019s Confections out of her home. She loves what she does, and she feels that she\u2019s doing pretty well. In fact, she has an opportunity to take over a nearby store at very reasonable rent, and she can expand by getting a modest bank loan and investing some more of her own money. So it\u00a0is decision time for Connie: She knows that the survival rate for start-ups isn\u2019t very good, and before taking the next step, she\u00a0would like to get a better idea of whether she\u2019s actually doing well enough to justify the risk. As you can see, she has several pertinent questions. We are not privy to Connie\u2019s finances, but we can tell her how basic financial statements will give her some answers.<span id=\"fwk-collins-fn12_008\" class=\"im_footnote\">We will discuss the <em class=\"im_emphasis\">statement of cash flows<\/em> later on.<\/span><\/p>\n<div id=\"collins-ch12_s02_s01_f10\" class=\"im_figure im_large im_editable im_block\">\n<div style=\"width: 604px\" class=\"wp-caption aligncenter\"><a href=\"https:\/\/textimgs.s3.amazonaws.com\/introbus\/section_16\/870be888c8d04e62fff9cd5e0c7039a4.jpg\" target=\"_blank\"><img loading=\"lazy\" decoding=\"async\" src=\"https:\/\/courses.candelalearning.com\/introbusiness2xmaster\/wp-content\/uploads\/sites\/182\/2014\/08\/sm_870be888c8d04e62fff9cd5e0c7039a4.jpg\" alt=\"To answer questions like, What were my sales this year? How much were my expenses this year? How much profit did I make this year? check the income statement. It shows what Connie\u2019s sales and expenses are and whether she made a profit. To answer questions like, What are my total assets at the end of this year? How much debt did I accumulate this year? How much did I spend on supplies this year? check the balance sheet. It shows what assets and liabilities Connie has and the amount that she\u2019s invested in her business. To answer questions like, How much money did I put into the company this year? How much of my profits did I put back in the company this year? check the statement of owner\u2019s equity. It shows changes in Connie\u2019s owner\u2019s equity over a specific period of time. To answer questions like, How much cash has the company brought in this year? When cash went out this year, how much of it went where? check statement of cash flows. It shows how much cash Connie has coming in and going out.\" width=\"594\" height=\"463\" \/><\/a><\/p>\n<p class=\"wp-caption-text\">Figure 1.\u00a0What Connie Wants to Know<\/p>\n<\/div>\n<\/div>\n<div id=\"collins-ch12_s02_s01_s01\" class=\"im_section\">\n<h2 class=\"im_title im_editable im_block\">Toying with a Business Idea<\/h2>\n<p>We know what you\u2019re thinking: It\u00a0is nice to know that accounting deals with real-life situations, but while you wish Connie the best, you do not know enough about the confectionary business to appreciate either the business decisions or the financial details. Is there any way to bring this lesson a little closer to home? Besides, while knowing what financial statements will tell you is one thing, you want to know how to <em class=\"im_emphasis\">prepare<\/em> them.<\/p>\n<p>Agreed. So let\u00a0us assume that you need to earn money while you\u2019re in college and that you\u2019ve decided to start a small business. Your business will involve selling stuff to other college students, and to keep things simple, we\u2019ll assume that you\u2019re going to operate on a \u201ccash\u201d basis: you\u2019ll pay for everything with cash, and everyone who buys something from you will pay in cash.<\/p>\n<p><em class=\"im_emphasis\">A Word about Cash.<\/em> You probably have at least a little <em class=\"im_emphasis\">cash<\/em> on you right now\u2014some currency, or paper money, and coins. In accounting, however, the term <em class=\"im_emphasis\">cash<\/em> refers to more than just paper money and coins. It also refers to the money that you have in checking and savings accounts and includes items that you can deposit in these accounts, such as money orders and different types of checks.<\/p>\n<p>Your first task is to decide exactly what you\u2019re going to sell. You\u00a0have noticed that with homework, exams, social commitments, and the hectic lifestyle of the average college student, you and most of the people you know always seem to be under a lot of stress. Sometimes you wish you could just lie back between meals and bounce a ball off the wall. And that\u2019s when the idea hits you: Maybe you could make some money by selling a product called the \u201cStress-Buster Play Pack.\u201d Here\u2019s what you have in mind: you\u2019ll buy small toys and other fun stuff\u2014instant stress relievers\u2014at a local dollar store and pack them in a rainbow-colored plastic treasure chest labeled \u201cStress-Buster.\u201d<\/p>\n<p>And here\u2019s where you stand: You have enough cash to buy a month\u2019s worth of plastic treasure chests and toys. After that, you\u2019ll use the cash generated from sales of Stress-Buster Play Packs to replenish your supply. Each plastic chest will cost $1.00, and you\u2019ll fill each one with a variety of five of the following toys, all of which you can buy for $1.00 each:<\/p>\n<ul id=\"collins-5300-20111123-080037-761756\" class=\"im_itemizedlist im_editable im_block\">\n<li>A happy face stress ball<\/li>\n<li>A roomarang (an indoor boomerang)<\/li>\n<li>Some silly putty<\/li>\n<li>An inflatable beach ball<\/li>\n<li>A coil \u201cslinky\u201d spring<\/li>\n<li>A paddle-ball game<\/li>\n<li>A ball for bouncing off walls<\/li>\n<\/ul>\n<p>You plan to sell each Stress-Buster Play Pack for $10 from a rented table stationed outside a major dining hall. Renting the table will cost you $20 a month. Because your own grades aren\u2019t what your parents and the dean would like them to be, you decide to hire fellow students (trustworthy people with better grades than yours) to staff the table at peak traffic periods. They\u2019ll be on duty from noon until 2:00 p.m. each weekday, and you\u2019ll pay them $6 an hour. Wages, therefore, will cost you $240 a month (2 hours \u00d7 5 days \u00d7 4 weeks = 40 hours \u00d7 $6). Finally, you\u2019ll run ads in the college newspaper at a monthly cost of $40. Thus your total monthly costs will amount to $300 ($20 + $240 + $40).<\/p>\n<\/div>\n<\/div>\n<div id=\"collins-ch12_s02_s02\" class=\"im_section\">\n<h2 class=\"im_title im_editable im_block\">The Income Statement<\/h2>\n<p>Let\u2019s say that during your first month, you sell one hundred play packs. Not bad, you say to yourself, but did I make a <em class=\"im_emphasis\">profit<\/em>? To find out, you prepare an <span class=\"im_margin_term\"><span class=\"im_glossterm\">income statement<\/span><\/span> showing <span class=\"im_margin_term\"><span class=\"im_glossterm\">revenues<\/span><\/span>, or <strong class=\"im_emphasis im_bold\">sales<\/strong>, and <span class=\"im_margin_term\"><span class=\"im_glossterm\">expenses<\/span><\/span>\u2014the costs of doing business. You divide your expenses into the following two categories:<\/p>\n<ul id=\"collins-5300-20111123-081006-080304\" class=\"im_itemizedlist im_editable im_block\">\n<li><span class=\"im_margin_term\"><span class=\"im_glossterm\">Cost of goods sold<\/span><\/span>: the total cost of the <em class=\"im_emphasis\">goods that you\u2019ve sold<\/em><\/li>\n<li><span class=\"im_margin_term\"><span class=\"im_glossterm\">Operating expenses<\/span><\/span>: the costs of <em class=\"im_emphasis\">operating your business<\/em> except for the costs of things that you\u2019ve sold<\/li>\n<\/ul>\n<p>Now you need to do a little subtracting, as follows:<\/p>\n<ol id=\"collins-5300-20111123-081819-852034\" class=\"im_orderedlist im_editable im_block\">\n<li>The positive difference between <em class=\"im_emphasis\">sales<\/em> and <em class=\"im_emphasis\">cost of goods sold<\/em> is your <span class=\"im_margin_term\"><span class=\"im_glossterm\">gross profit or gross margin<\/span><\/span>.<\/li>\n<li>The positive difference between <em class=\"im_emphasis\">gross profit<\/em> and <em class=\"im_emphasis\">operating expenses<\/em> is your <span class=\"im_margin_term\"><span class=\"im_glossterm\">net income<\/span><\/span> or <strong class=\"im_emphasis im_bold\">profit<\/strong>, which is the proverbial \u201cbottom line.\u201d (If this difference is <em class=\"im_emphasis\">negative<\/em>, you took a <em class=\"im_emphasis\">loss<\/em> instead of making a profit.)<\/li>\n<\/ol>\n<p>Figure 2, &#8220;Income Statement for Stress-Buster Company,&#8221; is your income statement for the first month. (Remember that we\u2019ve made things simpler by handling everything in cash.)<\/p>\n<div id=\"collins-ch12_s02_s02_f01\" class=\"im_figure im_large im_editable im_block\">\n<div style=\"width: 510px\" class=\"wp-caption aligncenter\"><a href=\"https:\/\/textimgs.s3.amazonaws.com\/introbus\/section_16\/a83af320f4e111497131740d8e877142.jpg\" target=\"_blank\"><img loading=\"lazy\" decoding=\"async\" src=\"https:\/\/courses.candelalearning.com\/introbusiness2xmaster\/wp-content\/uploads\/sites\/182\/2014\/08\/sm_a83af320f4e111497131740d8e877142.jpg\" alt=\"Income statement. Sales of 100 times 10 dollars equals 1,000. Less costs of goods sold of 100 times 6 dollars equals 600. Gross profit of 100 times 4 dollars is 400. 1 thousand minus 600 is 400. Less operating expenses. Salaries, 240. Advertising, 40. Table rental, 20. 240 plus 40 plus 20 equals 300. 400 minus 300 equals net income\/profit of 100 dollars.\" width=\"500\" height=\"322\" \/><\/a><\/p>\n<p class=\"wp-caption-text\">Figure 2.\u00a0Income Statement for Stress-Buster Company<\/p>\n<\/div>\n<\/div>\n<div id=\"collins-ch12_s02_s02_s02\" class=\"im_section\">\n<h2 class=\"im_title im_editable im_block\">Did You Make Any Money?<\/h2>\n<p>What does your income statement tell you? It has provided you with the following four pieces of valuable information:<\/p>\n<ol>\n<li>You sold 100 units at $10 each, bringing in <em class=\"im_emphasis\">revenues<\/em> or <em class=\"im_emphasis\">sales<\/em> of $1,000.<\/li>\n<li>Each unit that you sold cost you $6\u2014$1 for the treasure chest plus 5 toys costing $1 each. So your <em class=\"im_emphasis\">cost of goods sold<\/em> is $600 (100 units \u00d7 $6 per unit).<\/li>\n<li>Your <em class=\"im_emphasis\">gross profit<\/em>\u2014the amount left after subtracting cost of goods sold from sales\u2014is $400 (100 units \u00d7 $4 each).<\/li>\n<li>After subtracting <em class=\"im_emphasis\">operating expenses<\/em> of $300\u2014the costs of doing business other than the cost of products sold\u2014you generated a positive <em class=\"im_emphasis\">net income<\/em> or <em class=\"im_emphasis\">profit<\/em> of $100.<strong class=\"im_emphasis im_bold\"><br \/>\n<\/strong><\/li>\n<\/ol>\n<\/div>\n<div id=\"collins-ch12_s02_s02_s03\" class=\"im_section\">\n<h2 class=\"im_title im_editable im_block\">What If You Want to Make More Money?<\/h2>\n<p>You\u2019re quite relieved to see that you made a profit during your first month, but you can\u2019t help but wonder what you\u2019ll have to do to make even more money next month. You consider the following three possibilities:<\/p>\n<\/div>\n<ol id=\"collins-ch12_s02_s02_l01\" class=\"im_orderedlist im_editable im_block\">\n<li>Reduce your cost of goods sold (say, package four toys instead of five)<\/li>\n<li>Reduce your operating costs (salaries, advertising, table rental)<\/li>\n<li>Increase the quantity of units sold<\/li>\n<\/ol>\n<p>In order to consider these possibilities fully, you need to generate new income statements for each option. And to do that, you\u2019ll have to play a few \u201cwhat-if\u201d games. Because possibility #1\u2014packaging four toys instead of five\u2014is the most appealing, you start there. Your cost of goods sold would go down from $6 to $5 per unit (4 toys at $1 each + 1 plastic treasure chest at $1). Figure 3, &#8220;Proposed Income Statement Number One for Stress-Buster Company,&#8221; below, is your hypothetical income statement if you choose this option.<\/p>\n<div id=\"collins-ch12_s02_s02_f02\" class=\"im_figure im_large im_editable im_block\">\n<div style=\"width: 510px\" class=\"wp-caption aligncenter\"><a href=\"https:\/\/textimgs.s3.amazonaws.com\/introbus\/section_16\/f0512f21741e847e3be2eca2bc06f532.jpg\" target=\"_blank\"><img loading=\"lazy\" decoding=\"async\" src=\"https:\/\/courses.candelalearning.com\/introbusiness2xmaster\/wp-content\/uploads\/sites\/182\/2014\/08\/sm_f0512f21741e847e3be2eca2bc06f532.jpg\" alt=\"Income statement if cost of goods sold is $5 per unit. Sales of 100 times 10 dollars equals 1,000. Less costs of goods sold of 100 times 5 dollars equals 500. Gross profit of 100 times 5 dollars is 500. 1 thousand minus 500 is 500. Less operating expenses. Salaries, 240. Advertising, 40. Table rental, 20. 240 plus 40 plus 20 equals 300. 500 minus 300 equals net income\/profit of 200 dollars.\" width=\"500\" height=\"344\" \/><\/a><\/p>\n<p class=\"wp-caption-text\">Figure 3.\u00a0Proposed Income Statement Number One for Stress-Buster Company<\/p>\n<\/div>\n<\/div>\n<p>Possibility #1 seems to be a good idea. Under this scenario, your income doubles from $100 to $200 because your per-unit <em class=\"im_emphasis\">gross profit<\/em> increases by $1 (and you sold 100 stress packs). But there may be a catch: If you cut back on the number of toys, your customers might perceive your product as a lesser value for the money. In fact, you\u2019re reminded of a conversation that you once had with a friend whose father, a restaurant owner, had cut back on the cost of the food he served by buying less expensive meat. In the short term, gross profit per meal went up, but customers eventually stopped coming back and the restaurant nearly went out of business.<\/p>\n<p>Thus you decide to consider possibility #2\u2014reducing your operating costs. In theory, it\u2019s a good idea, but in practice\u2014at least in your case\u2014it probably won\u2019t work. Why not? For one thing, you can\u2019t do without the table and you need your workers (because your grades haven\u2019t improved, you still don\u2019t have time to sit at the table yourself). Second, if you cut salaries from, say, $6 to $5 an hour, you may have a hard time finding people willing to work for you. Finally, you could reduce advertising costs by running an ad every two weeks instead of every week, but this tactic would increase your income by only $20 a month and could easily lead to a drop in sales.<\/p>\n<p>Now you move on to possibility #3\u2014increase sales. The appealing thing about this option is that it has no downside. If you could somehow increase the number of units sold from 100 Stress-Buster packs per month to 150, your income would go up, even if you stick with your original five-toy product. So you decide to crunch some numbers for possibility #3 and come up with the new \u201cwhat-if\u201d income statement, below, Figure 4,\u00a0&#8220;Proposed Income Statement Number Two for Stress-Buster Company&#8221;:<\/p>\n<div id=\"collins-ch12_s02_s02_f03\" class=\"im_figure im_large im_editable im_block\">\n<div style=\"width: 510px\" class=\"wp-caption aligncenter\"><a href=\"https:\/\/textimgs.s3.amazonaws.com\/introbus\/section_16\/578d8a6e1acfbbdf9f6129ce29244d4f.jpg\" target=\"_blank\"><img loading=\"lazy\" decoding=\"async\" src=\"https:\/\/courses.candelalearning.com\/introbusiness2xmaster\/wp-content\/uploads\/sites\/182\/2014\/08\/sm_578d8a6e1acfbbdf9f6129ce29244d4f.jpg\" alt=\"Income statement if sales increase to 150 units. Sales of 150 times 10 dollars equals 1,500. Less costs of goods sold of 150 times 6 dollars equals 900. Gross profit of 150 times 4 dollars is 600. 1,500 minus 900 is 600. Less operating expenses. Salaries, 240. Advertising, 40. Table rental, 20. 240 plus 40 plus 20 equals 300. 600 minus 300 equals net income\/profit of 300 dollars.\" width=\"500\" height=\"339\" \/><\/a><\/p>\n<p class=\"wp-caption-text\">Figure 4.\u00a0Proposed Income Statement Number Two for Stress-Buster Company<\/p>\n<\/div>\n<\/div>\n<p>As you can see, this is an attractive possibility, even though you haven\u2019t figured out how you\u2019re going to increase sales (maybe you could put up some eye-popping posters and play cool music to attract people to your table. Or maybe your workers could attract buyers by demonstrating relaxation and stress-reduction exercises).<\/p>\n<div id=\"collins-ch12_s02_s02_s01\" class=\"im_section\">\n<h2 class=\"im_title im_editable im_block\">Break-Even Analysis<\/h2>\n<p>Playing these what-if games has started you thinking: is there some way to figure out the level of sales you need to avoid <em class=\"im_emphasis\">losing<\/em> money\u2014to \u201cbreak even\u201d? This can be done using <span class=\"im_margin_term\"><span class=\"im_glossterm\">break-even analysis<\/span><\/span>. To break even (have no profit or loss), your <em class=\"im_emphasis\">total sales revenue must exactly equal all your expenses (both variable and fixed)<\/em>. For a merchandiser, like a hypothetical one called The College Shop, this balance will occur when gross profit equals all other (fixed) costs. To determine the level of sales at which this will occur, you need to do the following:<\/p>\n<ol id=\"collins-ch12_s02_s02_s01_l01\" class=\"im_orderedlist im_editable im_block\">\n<li>Determine your total <span class=\"im_margin_term\"><span class=\"im_glossterm\">fixed costs<\/span><\/span>, which are so called because the total cost doesn\u2019t change as the quantity of goods sold changes):\n<ul id=\"collins-ch12_s02_s02_s01_l02\" class=\"im_itemizedlist\">\n<li>Fixed costs = $240 salaries + $40 advertising + $20 table = $300<\/li>\n<\/ul>\n<\/li>\n<li>Identify your <span class=\"im_margin_term\"><span class=\"im_glossterm\">variable costs<\/span><\/span>. These are costs that vary, in total, as the quantity of goods sold changes but stay constant on a per-unit basis. State variable costs on a per-unit basis:\n<ul id=\"collins-ch12_s02_s02_s01_l03\" class=\"im_itemizedlist\">\n<li>Variable cost per unit = $6 ($1 for the treasure chest and $5 for the toys)<\/li>\n<\/ul>\n<\/li>\n<li>Determine your <span class=\"im_margin_term\"><span class=\"im_glossterm\">contribution margin per unit<\/span><\/span>: selling price per unit \u2013 variable cost per unit:\n<ul id=\"collins-ch12_s02_s02_s01_l04\" class=\"im_itemizedlist\">\n<li>Contribution margin per unit = $10 selling price \u2013 $6 variable cost per unit = $4<\/li>\n<\/ul>\n<\/li>\n<li>Calculate your <span class=\"im_margin_term\"><span class=\"im_glossterm\">break-even point in units<\/span><\/span>: fixed costs \u00f7 contribution margin per unit:\n<ul id=\"collins-ch12_s02_s02_s01_l05\" class=\"im_itemizedlist\">\n<li>Breakeven in units = $300 fixed costs \u00f7 $4 contribution margin per unit = 75 units<\/li>\n<\/ul>\n<\/li>\n<\/ol>\n<p>Your calculation means that if you sell 75 units, you\u2019ll end up with zero profit (or loss) and will exactly break even. To test your calculation, you can prepare a what-if income statement for 75 units in sales (which is your break-even number of sales). The resulting statement is shown below in Figure 5, &#8220;Proposed Income Statement Number Three for Stress-Buster Company&#8221;:<\/p>\n<div id=\"collins-ch12_s02_s02_s01_f01\" class=\"im_figure im_large im_editable im_block\">\n<div style=\"width: 510px\" class=\"wp-caption aligncenter\"><a href=\"https:\/\/textimgs.s3.amazonaws.com\/introbus\/section_16\/2d1baf8a24cdf09f66e0f4b3ce39eda3.jpg\" target=\"_blank\"><img loading=\"lazy\" decoding=\"async\" src=\"https:\/\/courses.candelalearning.com\/introbusiness2xmaster\/wp-content\/uploads\/sites\/182\/2014\/08\/sm_2d1baf8a24cdf09f66e0f4b3ce39eda3.jpg\" alt=\"Income statement at break-even level of sales equals 75 units. Sales of 75 times 10 dollars equals 750. Less costs of goods sold of 75 times 6 dollars equals 450. Gross profit of 75 times 4 dollars is 300. 750 minus 450 is 300. Less operating expenses. Salaries, 240. Advertising, 40. Table rental, 20. 240 plus 40 plus 20 equals 300. 300 minus 300 equals net income\/profit of zero dollars.\" width=\"500\" height=\"340\" \/><\/a><\/p>\n<p class=\"wp-caption-text\">Figure 5.\u00a0Proposed Income Statement Number Three for Stress-Buster Company<\/p>\n<\/div>\n<\/div>\n<p>What if you want to do better than just break even? What if you want to earn a profit of $200 next month? How many Stress-Buster Pack units would you need to sell? You can find out by building on the results of your break-even analysis. Note that each additional sale will bring in $4 (contribution margin per unit). If you want to make a profit of $200\u2014which is $200 <em class=\"im_emphasis\">above your break-even point<\/em>\u2014you must sell an additional 50 units ($200 desired profit divided by $4 contribution margin per unit) above your break-even point of 75 units. If you sell 125 units (75 break-even units + the additional 50), you\u2019ll make a profit of $200 a month.<\/p>\n<p>As you can see, break-even analysis is rather handy. It enables you to determine the level of sales that you must reach to avoid losing money and the level of sales that you have to reach to earn a profit of $200. Such information will help you plan for your business. For example, knowing you must sell 125 Stress-Buster Packs to earn a $200 profit will help you decide how much time and money you need to devote to marketing your product.<\/p>\n<\/div>\n<\/div>\n<div id=\"collins-ch12_s02_s03\" class=\"im_section\">\n<h2 class=\"im_title im_editable im_block\">The Balance Sheet<\/h2>\n<p>Your <span class=\"im_margin_term\"><span class=\"im_glossterm\">balance sheet<\/span><\/span> reports the following information:<\/p>\n<ul id=\"collins-ch12_s02_s03_l01\" class=\"im_itemizedlist im_editable im_block\">\n<li>Your <span class=\"im_margin_term\"><span class=\"im_glossterm\">assets<\/span><\/span>: the resources from which it expects to gain some future benefit<\/li>\n<li>Your <span class=\"im_margin_term\"><span class=\"im_glossterm\">liabilities<\/span><\/span>: the debts that it owes to <em class=\"im_emphasis\">outside<\/em> individuals or organizations<\/li>\n<li>Your <span class=\"im_margin_term\"><span class=\"im_glossterm\">owner\u2019s equity<\/span><\/span>: your investment in your business<\/li>\n<\/ul>\n<p>Whereas your income statement tells you how much income you earned <em class=\"im_emphasis\">over some period of time<\/em>, your balance sheet tells you what you have (and where it came from) <em class=\"im_emphasis\">at a specific point in time<\/em>.<\/p>\n<p>Most companies prepare financial statements on a twelve-month basis\u2014that is, for a <span class=\"im_margin_term\"><span class=\"im_glossterm\">fiscal year<\/span><\/span> which ends on December 31 or some other logical date, such as June 30 or September 30. Why do fiscal years vary? A company generally picks a fiscal-year end date that coincides with the end of its peak selling period; thus a crabmeat processor might end its fiscal year in October, when the crab supply has dwindled. Most companies also produce financial statements on a quarterly or monthly basis. For Stress-Buster, you\u2019ll want to prepare a monthly balance sheet.<\/p>\n<div id=\"collins-ch12_s02_s03_s01\" class=\"im_section\">\n<h2 class=\"im_title im_editable im_block\">The Accounting Equation<\/h2>\n<p>The balance sheet is based on the <span class=\"im_margin_term\"><span class=\"im_glossterm\">accounting equation, as follows<\/span><\/span>:<span class=\"im_informalequation im_block\"><br \/>\n<span class=\"im_mathphrase\">assets = liabilities + owner\u2019s equity<\/span><br \/>\n<\/span><\/p>\n<p>This important equation highlights the fact that a company\u2019s <em class=\"im_emphasis\">assets<\/em> came from somewhere: either from loans (<em class=\"im_emphasis\">liabilities<\/em>) or from investments made by the owners (<em class=\"im_emphasis\">owner\u2019s equity<\/em>). This means that the asset section of the balance sheet on the one hand and the liability and owner\u2019s-equity section on the other must be equal, or <em class=\"im_emphasis\">balance<\/em>. Thus the term <em class=\"im_emphasis\">balance sheet<\/em>.<\/p>\n<p>Let\u2019s prepare two balance sheets for your company: one for the first day you started and one for the end of your first month of business. We\u2019ll assume that when you started Stress-Buster, you borrowed $400 from your parents and put in $200 of your own money. If you look at your first balance sheet, below, in Figure 6, &#8220;Balance Sheet Number One for Stress-Buster Company,&#8221; you\u2019ll see that your business has $600 in cash (your <em class=\"im_emphasis\">assets<\/em>): Of this total, you borrowed $400 (your <em class=\"im_emphasis\">liabilities<\/em>) and invested $200 of your own money (your <em class=\"im_emphasis\">owner\u2019s equity<\/em>). So far, so good: Your assets section <em class=\"im_emphasis\">balances<\/em> with your liabilities and owner\u2019s equity section.<\/p>\n<div id=\"collins-ch12_s02_s03_s01_f01\" class=\"im_figure im_large im_editable im_block\">\n<div style=\"width: 510px\" class=\"wp-caption aligncenter\"><a href=\"https:\/\/textimgs.s3.amazonaws.com\/introbus\/section_16\/ad541ca3dedf5ae31cdd2d2388fd0300.jpg\" target=\"_blank\"><img loading=\"lazy\" decoding=\"async\" class=\"\" src=\"https:\/\/courses.candelalearning.com\/introbusiness2xmaster\/wp-content\/uploads\/sites\/182\/2014\/08\/sm_ad541ca3dedf5ae31cdd2d2388fd0300.jpg\" alt=\"Balance Sheet. Assets: cash, 600 dollars. Liabilities and owner's equity. Liabilities, 400. Owner's equity, 200. Total liabilities and owner's equity is 600 dollars.\" width=\"500\" height=\"271\" \/><\/a><\/p>\n<p class=\"wp-caption-text\">Figure 6.\u00a0Balance Sheet Number One for Stress-Buster Company<\/p>\n<\/div>\n<\/div>\n<p>Now let\u2019s see how things have changed by the end of the month. Recall that Stress-Buster earned $100 (based on sales of 100 units) during the month of September and that you decided to leave these earnings in the business. This $100 profit increases two items on your <em class=\"im_emphasis\">balance sheet<\/em>: the <em class=\"im_emphasis\">assets<\/em> of the company (its cash) and your investment in it (its <em class=\"im_emphasis\">owner\u2019s equity<\/em>). Below, Figure 7,\u00a0&#8220;Balance Sheet Number Two for Stress-Buster Company,&#8221; shows what your balance sheet will look like on September 30. Once again, it <em class=\"im_emphasis\">balances<\/em>. You now have $700 in cash: $400 that you borrowed plus $300 that you\u2019ve invested in the business (your original $200 investment plus the $100 profit from the first month of operations, which you\u2019ve kept in the business).<\/p>\n<div id=\"collins-ch12_s02_s03_s01_f02\" class=\"im_figure im_large im_editable im_block\">\n<div style=\"width: 510px\" class=\"wp-caption aligncenter\"><a href=\"https:\/\/textimgs.s3.amazonaws.com\/introbus\/section_16\/3f3290aee0cf88bb730eb9556484cf55.jpg\" target=\"_blank\"><img loading=\"lazy\" decoding=\"async\" src=\"https:\/\/courses.candelalearning.com\/introbusiness2xmaster\/wp-content\/uploads\/sites\/182\/2014\/08\/sm_3f3290aee0cf88bb730eb9556484cf55.jpg\" alt=\"Balance Sheet. Assets: cash, (original 600 dollars plus 100 dollars earned) equals 700 dollars. Liabilities and owner's equity. Liabilities, 400. Owner's equity, 200 dollars invested by owner plus 100 dollar profits retained) equals 300 dollars. Total liabilities and owner's equity is 700 dollars.\" width=\"500\" height=\"304\" \/><\/a><\/p>\n<p class=\"wp-caption-text\">Figure 7.\u00a0Balance Sheet Number Two for Stress-Buster Company<\/p>\n<\/div>\n<\/div>\n<\/div>\n<\/div>\n<div id=\"collins-ch12_s02_s04\" class=\"im_section\">\n<h2 class=\"im_title im_editable im_block\">The Statement of Owner\u2019s Equity<\/h2>\n<p>Note that we used the <em class=\"im_emphasis\">net income<\/em> figure from your <em class=\"im_emphasis\">income statement<\/em> to update the owner\u2019s equity section of your end-of-month balance sheet. Often, companies prepare an additional financial statement, called the <span class=\"im_margin_term\"><span class=\"im_glossterm\">statement of owner\u2019s equity<\/span><\/span>, which details changes in owner\u2019s equity for the reporting period. Figure 8, &#8220;Sample Statement of Owner\u2019s Equity for Stress-Buster Company,&#8221; shows what this statement looks like.<\/p>\n<div id=\"collins-ch12_s03_f99\" class=\"im_figure im_large im_editable im_block\">\n<div style=\"width: 510px\" class=\"wp-caption aligncenter\"><a href=\"https:\/\/textimgs.s3.amazonaws.com\/introbus\/section_16\/007821ed2cb6dac773edc41bfbe38876.jpg\" target=\"_blank\"><img loading=\"lazy\" decoding=\"async\" src=\"https:\/\/courses.candelalearning.com\/introbusiness2xmaster\/wp-content\/uploads\/sites\/182\/2014\/08\/sm_007821ed2cb6dac773edc41bfbe38876.jpg\" alt=\"Statement of Owner's Equity. 200 dollars plus net income 100 dollars. Owner's equity is 300 dollars.\" width=\"500\" height=\"220\" \/><\/a><\/p>\n<p class=\"wp-caption-text\">Figure 8. Sample Statement of Owner\u2019s Equity for Stress-Buster Company<\/p>\n<\/div>\n<\/div>\n<\/div>\n<div id=\"collins-ch12_s02_s05\" class=\"im_section\">\n<h2 class=\"im_title im_editable im_block\">How Do Financial Statements Relate to One Another?<\/h2>\n<p>When you prepare your financial statements, you should complete them in the following\u00a0order:<\/p>\n<ol id=\"collins-5300-20111123-092319-468167\" class=\"im_orderedlist im_editable im_block\">\n<li>Income statement<\/li>\n<li>Statement of owner\u2019s equity<\/li>\n<li>Balance sheet<\/li>\n<\/ol>\n<p>Why must they be prepared in this order? Because financial statements are interrelated: Numbers generated on one financial statement appear on other financial statements. Figure 9, &#8220;How Financial Statements Relate to One Another,&#8221; presents Stress-Buster\u2019s financial statements for the month ended September 30, 20X1. As you review these statements, note that in two cases, numbers from one statement appear in another statement:<\/p>\n<div id=\"attachment_3736\" style=\"width: 510px\" class=\"wp-caption aligncenter\"><a href=\"https:\/\/courses.lumenlearning.com\/wmintrobusinessx51xmaster\/wp-content\/uploads\/sites\/135\/2015\/06\/How-Financial-Statements-Relate.jpg\"><img loading=\"lazy\" decoding=\"async\" aria-describedby=\"caption-attachment-3736\" class=\"wp-image-3736\" src=\"https:\/\/courses.lumenlearning.com\/wmintrobusinessx51xmaster\/wp-content\/uploads\/sites\/135\/2015\/06\/How-Financial-Statements-Relate-440x1024.jpg\" alt=\"The net income for the month on the income statement is also on the statement of owner\u2019s equity as an addition to the beginning Owner\u2019s equity balance. This addition of $100 increases the balance in owner\u2019s equity from $200 to $300. The ending owner\u2019s equity balance of $300 also appears on the balance sheet as owner\u2019s equity.\" width=\"500\" height=\"1164\" srcset=\"https:\/\/courses.lumenlearning.com\/wmintrobusinessx51xmaster\/wp-content\/uploads\/sites\/135\/2015\/06\/How-Financial-Statements-Relate-440x1024.jpg 440w, https:\/\/courses.lumenlearning.com\/wmintrobusinessx51xmaster\/wp-content\/uploads\/sites\/135\/2015\/06\/How-Financial-Statements-Relate-129x300.jpg 129w, https:\/\/courses.lumenlearning.com\/wmintrobusinessx51xmaster\/wp-content\/uploads\/sites\/135\/2015\/06\/How-Financial-Statements-Relate-65x151.jpg 65w, https:\/\/courses.lumenlearning.com\/wmintrobusinessx51xmaster\/wp-content\/uploads\/sites\/135\/2015\/06\/How-Financial-Statements-Relate-225x524.jpg 225w, https:\/\/courses.lumenlearning.com\/wmintrobusinessx51xmaster\/wp-content\/uploads\/sites\/135\/2015\/06\/How-Financial-Statements-Relate-350x815.jpg 350w, https:\/\/courses.lumenlearning.com\/wmintrobusinessx51xmaster\/wp-content\/uploads\/sites\/135\/2015\/06\/How-Financial-Statements-Relate.jpg 1097w\" sizes=\"auto, (max-width: 500px) 100vw, 500px\" \/><\/a><\/p>\n<p id=\"caption-attachment-3736\" class=\"wp-caption-text\">Figure 9.\u00a0How Financial Statements Relate to One Another<\/p>\n<\/div>\n<div id=\"collins-ch12_s02_s03_s01_f99\" class=\"im_figure im_full im_editable im_block\"><\/div>\n<p>If the interlinking numbers are carried forward correctly, and if assets and liabilities are listed correctly, then the balance sheet will <em class=\"im_emphasis\">balance<\/em>: Total <em class=\"im_emphasis\">assets<\/em> will equal the total of <em class=\"im_emphasis\">liabilities<\/em> plus <em class=\"im_emphasis\">owner\u2019s equity<\/em>.<\/p>\n<div id=\"collins-ch12_s02_s03_s01_n01\" class=\"im_key_takeaways im_block\">\n<div class=\"keytakeaways\">\n<h3>KEY TAKEAWAYS<\/h3>\n<ul id=\"collins-ch12_s02_s03_s01_l01\" class=\"im_itemizedlist\">\n<li>Accountants prepare four <strong class=\"im_emphasis im_bold\">financial statements<\/strong>: <em class=\"im_emphasis\">income statement<\/em>, <em class=\"im_emphasis\">statement of owner\u2019s equity<\/em>, <em class=\"im_emphasis\">balance sheet<\/em>, and <em class=\"im_emphasis\">statement of cash flows<\/em> (which is discussed later in the chapter).<\/li>\n<li>The <strong class=\"im_emphasis im_bold\">income statement<\/strong> shows a firm\u2019s <strong class=\"im_emphasis im_bold\">revenues<\/strong> and <strong class=\"im_emphasis im_bold\">expenses<\/strong> and whether it made a profit.<\/li>\n<li>The <strong class=\"im_emphasis im_bold\">balance sheet<\/strong> shows a firm\u2019s <strong class=\"im_emphasis im_bold\">assets<\/strong>, <strong class=\"im_emphasis im_bold\">liabilities<\/strong> and<strong class=\"im_emphasis im_bold\"> owner\u2019s equity<\/strong> (the amount that its owners have invested in it).<\/li>\n<li>The balance sheet is based on the <strong class=\"im_emphasis im_bold\">accounting equation<\/strong>:<span class=\"im_informalequation\"><br \/>\n<span class=\"im_mathphrase\">assets = liabilities + owner\u2019s equity<\/span><br \/>\n<\/span>This equation highlights the fact that a company\u2019s <em class=\"im_emphasis\">assets<\/em> came from one of two sources: either from loans (its <em class=\"im_emphasis\">liabilities<\/em>) or from investments made by owners (its <em class=\"im_emphasis\">owner\u2019s equity<\/em>).<\/li>\n<li>The <strong class=\"im_emphasis im_bold\">statement of owner\u2019s equity<\/strong> reports the changes in owner\u2019s equity that have occurred over a specified period of time.<\/li>\n<li>Financial statements should be competed in a certain order: <em class=\"im_emphasis\">income statement<\/em>, <em class=\"im_emphasis\">statement of owner\u2019s equity<\/em>, and <em class=\"im_emphasis\">balance sheet<\/em>. These financial statements are interrelated because numbers generated on one financial statement appear on other financial statements.<\/li>\n<li><strong class=\"im_emphasis im_bold\">Break-even analysis<\/strong> is a technique used to determine the level of sales needed to break even\u2014to operate at a sales level at which you have neither profit nor loss.<\/li>\n<li>To break even, total sales revenue must exactly equal all your expenses (both <strong class=\"im_emphasis im_bold\">variable<\/strong> and <strong class=\"im_emphasis im_bold\">fixed costs<\/strong>).<\/li>\n<li>To calculate the <strong class=\"im_emphasis im_bold\">break-even point in units<\/strong> to be sold, you divide fixed costs by <strong class=\"im_emphasis im_bold\">contribution margin per unit<\/strong> (selling price per unit minus variable cost per unit).<\/li>\n<li>This technique can also be used to determine the level of sales needed to obtain a specified profit.<\/li>\n<\/ul>\n<\/div>\n<\/div>\n<\/div>\n\n\t\t\t <section class=\"citations-section\" role=\"contentinfo\">\n\t\t\t <h3>Candela Citations<\/h3>\n\t\t\t\t\t <div>\n\t\t\t\t\t\t <div id=\"citation-list-858\">\n\t\t\t\t\t\t\t <div class=\"licensing\"><div class=\"license-attribution-dropdown-subheading\">CC licensed content, Shared previously<\/div><ul class=\"citation-list\"><li>An Introduction to Business. <strong>Authored by<\/strong>: Anonymous. <strong>Provided by<\/strong>: Anonymous. <strong>Located at<\/strong>: <a target=\"_blank\" href=\"http:\/\/2012books.lardbucket.org\/books\/an-introduction-to-business-v2.0\/s16-the-role-of-accounting-in-busi.html\">http:\/\/2012books.lardbucket.org\/books\/an-introduction-to-business-v2.0\/s16-the-role-of-accounting-in-busi.html<\/a>. <strong>License<\/strong>: <em><a target=\"_blank\" rel=\"license\" href=\"https:\/\/creativecommons.org\/licenses\/by-nc-sa\/4.0\/\">CC BY-NC-SA: Attribution-NonCommercial-ShareAlike<\/a><\/em><\/li><\/ul><\/div>\n\t\t\t\t\t\t <\/div>\n\t\t\t\t\t <\/div>\n\t\t\t <\/section>","protected":false},"author":78,"menu_order":7,"template":"","meta":{"_candela_citation":"[{\"type\":\"cc\",\"description\":\"An Introduction to Business\",\"author\":\"Anonymous\",\"organization\":\"Anonymous\",\"url\":\"http:\/\/2012books.lardbucket.org\/books\/an-introduction-to-business-v2.0\/s16-the-role-of-accounting-in-busi.html\",\"project\":\"\",\"license\":\"cc-by-nc-sa\",\"license_terms\":\"\"}]","CANDELA_OUTCOMES_GUID":"c186f142-2786-4357-a4a2-d24e0ff68e77","pb_show_title":"on","pb_short_title":"","pb_subtitle":"","pb_authors":[],"pb_section_license":""},"chapter-type":[],"contributor":[],"license":[],"class_list":["post-858","chapter","type-chapter","status-publish","hentry"],"part":94,"_links":{"self":[{"href":"https:\/\/courses.lumenlearning.com\/wmintrobusinessx51xmaster\/wp-json\/pressbooks\/v2\/chapters\/858","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/courses.lumenlearning.com\/wmintrobusinessx51xmaster\/wp-json\/pressbooks\/v2\/chapters"}],"about":[{"href":"https:\/\/courses.lumenlearning.com\/wmintrobusinessx51xmaster\/wp-json\/wp\/v2\/types\/chapter"}],"author":[{"embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/wmintrobusinessx51xmaster\/wp-json\/wp\/v2\/users\/78"}],"version-history":[{"count":15,"href":"https:\/\/courses.lumenlearning.com\/wmintrobusinessx51xmaster\/wp-json\/pressbooks\/v2\/chapters\/858\/revisions"}],"predecessor-version":[{"id":5349,"href":"https:\/\/courses.lumenlearning.com\/wmintrobusinessx51xmaster\/wp-json\/pressbooks\/v2\/chapters\/858\/revisions\/5349"}],"part":[{"href":"https:\/\/courses.lumenlearning.com\/wmintrobusinessx51xmaster\/wp-json\/pressbooks\/v2\/parts\/94"}],"metadata":[{"href":"https:\/\/courses.lumenlearning.com\/wmintrobusinessx51xmaster\/wp-json\/pressbooks\/v2\/chapters\/858\/metadata\/"}],"wp:attachment":[{"href":"https:\/\/courses.lumenlearning.com\/wmintrobusinessx51xmaster\/wp-json\/wp\/v2\/media?parent=858"}],"wp:term":[{"taxonomy":"chapter-type","embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/wmintrobusinessx51xmaster\/wp-json\/pressbooks\/v2\/chapter-type?post=858"},{"taxonomy":"contributor","embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/wmintrobusinessx51xmaster\/wp-json\/wp\/v2\/contributor?post=858"},{"taxonomy":"license","embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/wmintrobusinessx51xmaster\/wp-json\/wp\/v2\/license?post=858"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}