5 Comparing sole trader and company financial statement formats

The balance sheet is the fundamental financial statement because it expresses the balance sheet equation (Assets = Capital + Liabilities or Assets – Liabilities = Capital) which underlies double-entry bookkeeping and financial accounting. The balance sheet summarises the balances in the general ledger accounts related to assets (the resources of the business), liabilities (the debts and other obligations of the business) and capital (the owners’ equity) at a date. The balance sheet shows the financial position of the business at a point in time.

The income statement summarises the changes in assets and liabilities (recorded as the flow of income and expenses during a period of time) that generated the profit or loss for the period. The income statement shows the financial performance of the business over a period of time.

Flow statements for a period link the balance sheet at the start of the period to the balance sheet at the end of the period. The income statement is a flow statement because it shows how income and expenses caused the increase or decrease in capital from one period to the next. The cash flow statement is a flow statement because it shows the increase or decrease in cash from one period to the next. The statement of changes in equity is also a flow statement.

Figure 6 below shows an example of how the flow statements link the opening and closing balance sheets.

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Figure 6 An example showing the relationship between stocks and flows of William’s business

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Figure 6 shows William’s balance sheet as at 2 January on the left hand side (the stock statement at the start of the period) and William’s balance sheet as at 6 January on the right hand side (the stock statement at the end of the period). The stock statement at the start of the period shows Bank £10,000 in blue and Owner’s capital £10,000 in purple. Debit side: Total assets £10,000 = Credit side: Total capital £10,000. The stock statement at the end of the period shows Bank £7,400 in blue and owner’s capital £11,400 in purple. In black it shows also on the debit side the assets of van £4,000 and computer £2,000. In black it shows on the credit side a loan of £2,000. Hence total assets (Bank + Van + Computer) £13,400 = total capital and liabilities £13,400. The flow statements link these two balance sheets at two points in time by showing what happened during that period. The first flow statement is the income statement for the period ended 6 January. It shows in black £1,500 sales less £1,000 cost of sales = £500 profit, whereby the profit number is shown in orange. The second flow statement is William’s cash flow statement which reconciles the opening bank balance of £10,000 at 2 January with the closing bank balance of £7,400 at 6 January (both in blue). Opening cash £10,000 plus £3,500 cash inflow less £6,100 cash outflow leads to a net cash outflow of £2,600 during the period. The third flow statement is William’s statement of changes in capital for the period ended 6 January which reconciles opening capital £10,000 (purple) to closing capital £11,400 (purple) by adding £1,000 of capital introduced during the period and the profit for the period of £500 (orange), and then deducting drawings of £100.

Figure 6 An example showing the relationship between stocks and flows of William’s business

In Section 5.1 you will look at the balance sheet and income statement for a sole trader. In Section 5.2 you will look at the same financial statements for a company. Section 5.3 discusses the statement of changes in equity for a company and Section 5.4 looks at cashflow statement for a company.