Financial Statements

Purpose

Financial statements show how a business is performing and what it owns and owes. Owners, banks, KRA and investors use them. In Kenya, a duka owner, a matatu SACCO and a large company all rely on the same basic principles.

The income statement

Also called the trading, profit and loss account. It covers a period, usually one year.

Trading section

• Net sales = sales - returns inwards
• Cost of goods sold = opening stock + purchases - closing stock
• Gross profit = net sales - COGS

Profit and loss section

• Add other incomes (commission, rent received).
• Deduct expenses (rent, wages, electricity, depreciation).
• Result: net profit (or net loss).

Worked example

Sales KES 800,000; opening stock 100,000; purchases 450,000; closing stock 70,000; expenses 150,000.

• COGS = 100,000 + 450,000 - 70,000 = 480,000
• Gross profit = 800,000 - 480,000 = 320,000
• Net profit = 320,000 - 150,000 = 170,000

Statement of financial position

Shows assets, liabilities and capital at a given date.

• Non-current assets: last more than one year (land, buildings, machinery, vehicles).
• Current assets: cash, bank, debtors, stock.
• Current liabilities: due within a year (creditors, overdraft).
• Non-current liabilities: loans repayable after a year.
• Capital: owner's investment plus profit less drawings.

Accounting equation: Assets = Capital + Liabilities.

Depreciation

Non-current assets lose value through use. Straight-line method: (cost - residual value) / useful life. A van costing KES 1,200,000 with scrap value KES 200,000 over 5 years depreciates by 200,000 per year.

Ratio analysis

• Gross profit margin = gross profit / sales x 100
• Net profit margin = net profit / sales x 100
• Current ratio = current assets / current liabilities (ideal about 2:1)
• Stock turnover = COGS / average stock

Using the earlier example: gross margin = 320,000 / 800,000 x 100 = 40%; net margin = 170,000 / 800,000 x 100 = 21.25%.

Adjustments

Before final accounts, adjust for accrued expenses (owed but unpaid, added), prepaid expenses (paid in advance, deducted), bad debts and depreciation.

Mobile money and records

Many Kenyan traders use M-Pesa. Statements still require recording each transaction in a cash book so that income and costs reconcile with business and personal use.

Try it

• Prepare an income statement from your own sample figures.
• A business has current assets of KES 240,000 and current liabilities of KES 120,000. Find the current ratio and comment.
• Compute straight-line depreciation for a KES 90,000 sewing machine lasting 6 years, scrap value KES 6,000.