This is a brief overview to introduce non-accountants to reading and understanding financial statements. First off, we're only going to address the Income Statement and Balance Sheet in this article. Just know that there is a Cash Flow Statement, Statement of Shareholders' Equity, and sometimes a separate Statement of Comprehensive Income.

There are usually three items of most interest on an income statement. They are:

1. revenues/sales, or in the case of a bank, net interest income.
2. cost of goods sold/cost of sales, or in the case of a bank, net interest expense.
3. net income

When a company realizes revenue, hopefully they are receiving cash or something called accounts receivable if their industry typically allows payment terms to customers such as payment due in 30 days. To illustrate this concept, let's say this month your company sold $10,000, and all of it is due in 30 days. Last month let's say you sold $11,000, and it was all sold on the 1^st of the month so it's now due. Today, you'd have total year to date sales of $21,000 ($11,000 + $10,000), cash of $11,000 (assuming every customer paid on time -- we'll get to other scenarios in future articles), and $10,000 in accounts receivable. At the end of the previous month, you had total year to date sales of $11,000, no cash, and $11,000 in accounts receivable. During the current month, you converted that $11,000 in accounts receivable to cash, and recorded this month's $10,000 of sales in accounts receivable.

This month's sales $10,000

Prior month's sales $11,000

Total year to date sales $21,000

Accounts receivable $10,000 end of this month; $11,000 end of prior month

Cash $11,000 end of this month; $0 end of prior month

Congratulations, you've just grasped the concept of period accounting and period end accounting.

Now let's look at the expense side of a sale since it costs money to make money. When people refer to "margins", they are usually referring to the gross margin or what's "left over" after the costs of making, transporting, and storing the product prior to sale is subtracted from the sales price. There are other margin definitions we can explore in future articles. Building on our example:

Let's say that each product is sold for $50, and the related costs are $30. The margin is 40% (($50-$30)/$50)). Since you sold $10,000 this month, that computes to 200 units at $50 each. Today, you'd have total year to date cost of sales of $12,600 (60% x $21,000 or $30 x 420 units). Assuming your vendors allow you payment terms of 30 days, you'd have paid out cash of $6,600 for last month's sales (60% x $11,000 or $30 x 220 units), and have accounts payable of $6,000 for what you owe your vendors for this month's sales.

This month's cost of sales $6,000

Prior month's cost of sales $6,600

Total year to date cost of sales $12,600

Accounts payable $6,000 end of this month; $6,600 end of prior month

Cash $4,400 end of this month; $0 end of prior month

Cash is affected by the $6,600 you paid this month as well as the $11,000 you received.

In future articles, we'll explore other items that are triggered by sales such as an allowance for doubtful accounts for customer accounts we may be unable to collect from, returns, and warranty reserves.

In this simple example, our business is considered profitable because net income is $8,400 ($21,000 total year to date sales exceed $12,600 in total year to date cost of sales). Of course there would be other expenses for sales, accounting, and taxes we can add to our example later.

Let's look at our company's current account balances in a different format:

Sales $21,000

Cost of Sales $12,600

Gross Margin $6,600

Net Income $6,600

Cash $ 4,400

Accounts Receivable $10,000

Accounts Payable $6,000

Now let's add a few headings:

Income Statement

For the Period Ending This Month

Sales $21,000

Cost of Sales $12,600

Gross Margin $ 6,600

Net Income $ 6,600

Balance Sheet

End of Month Date

Cash $ 4,400

Accounts Receivable $10,000

Total Assets $14,400

Accounts Payable $ 6,000

Total Liabilities $6,000

Looks like we have to add another category to the balance sheet since balance sheets balance:

Balance Sheet

End of Month Date

Cash $ 4,400

Accounts Receivable $10,000

Total Assets $14,400

Accounts Payable $ 6,000

Total Liabilities $ 6,000

Net Income/

Retained Earnings $8,400

Total Shareholders' Equity $8,400

Total Liabilities and

Shareholders' Equity $14,400

Now take a look at your own company's balance sheet and income statement or the balance sheet and income statement of a company in which you own shares. Congratulations! You've got the basic concepts of how to read a balance sheet, income statement, and how the income statement affects the balance sheet. Without even trying, you've also been introduced to the concept that the balance sheet represents account balances as of the end of a period in time such as the end of the month, and the income statement reflects the activities over a period such as a year.