After recording transactions, a business pulls the information together into financial statements. Why bother? Understanding their purpose makes the point of accounting clear.

Every receipt kept, sale written down and payment recorded is only raw material. Financial statements turn that pile of daily detail into two clear answers a reader can use.

The two main statements

At this level, two statements matter most.

  • The income statement shows whether the business made a profit or a loss over a period of time, such as a year. It answers: did we do well?
  • The statement of financial position shows what the business owns and owes at a single date. It answers: what is our position right now?

Together they summarise performance over time and position at a moment. Look closely at the difference in wording, because students mix it up most often. The income statement covers a stretch of time, everything that happened between one date and another.

The statement of financial position is a snapshot on one chosen day, usually the last day of the period. One is a film of the year. The other is a photograph taken at the final second of it.

A quick worked example

Imagine a small stationery shop over one year. It sells RM90,000 of goods. The goods it sold had cost the shop RM55,000, and running costs (rent, wages, electricity) came to RM25,000.

Its income statement lines these up. Revenue of RM90,000, less cost of goods sold of RM55,000, gives a gross profit of RM35,000.

Less the RM25,000 of running costs, that gives a profit for the year of RM10,000. That RM10,000 answers “did we do well?” for the whole twelve months.

Now the statement of financial position, drawn up on the last day of that year. It might show the shop owns RM12,000 of unsold stock, RM8,000 of equipment and RM6,000 in the bank, and owes RM4,000 to suppliers it has not yet paid. Those figures describe the shop’s position on that one date, not what happened across the year.

The two statements come from the same records yet answer different questions. That is why a business prepares both.

Who reads them, and why

Financial statements are not just for the owner. Different people rely on them.

  • The owner, to judge whether the business is worth continuing and where to improve.
  • Banks and lenders, to decide whether lending is safe.
  • Suppliers, to decide whether to offer credit.
  • Tax authorities, to work out tax owed.
  • Possible investors or partners, to decide whether putting money in is sensible.

So many people depend on them that statements follow consistent rules, which is what the course teaches. Think of the lender in our stationery example. A RM10,000 profit is reassuring, but the lender will also check the statement of financial position to see the shop is not weighed down by amounts it owes.

One statement alone can mislead. Read together, they give a fuller picture. That is why examiners expect you to understand both, not just produce numbers.

Profit is not the same as cash

A business can report a profit and still be short of cash. It can also hold plenty of cash while making a loss.

In our shop, the RM10,000 profit does not mean RM10,000 is sitting in the bank. Some of it may be tied up in unsold stock or in amounts customers still owe.

Profit is measured on the income statement. Cash and amounts owed appear on the statement of financial position. Keeping the two ideas apart now will save you from a very common mistake later.

From records to statements

The path is: record each transaction (double entry), gather balances (the ledger and trial balance), then summarise into statements. Every neat entry is a small step toward statements that can be trusted. Careless recording produces misleading statements.

Say one sale in our shop had been written down twice. The profit would look higher than it really is, and every reader would be misled, whether owner, lender or supplier. The final statements are only as reliable as the recording underneath.

Why this matters for your studies

Knowing the purpose of the statements helps you produce them well. When you prepare an income statement, you are answering “did the business make a profit?”

Make it clear enough for a reader to see the answer at a glance.

A tidy layout with subtotals in the right places is not decoration. It lets a busy lender find the profit figure in seconds.

Later topics such as adjustments, depreciation and provisions all exist to make these two statements tell the truth more faithfully. Keeping hold of the “why” stops the detail feeling random.

Try it yourself

Exercise: Which statement would you look at to answer each question? (a) “Did the business make a profit this year?” (b) “How much does the business owe right now?”

Show the answer
  • (a) The income statement: it reports profit or loss over the year.
  • (b) The statement of financial position: it shows what is owned and owed at a point in time.

To see one built, read a simple income statement.

If it is still hard to tell which statement answers which question, one of our teachers can work through your own examples with you. The purpose of each statement will then become clear. Book a trial class.