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Lesson 3 of 5Business Functions
Unit 3 · Lesson 3 of 5

Accounting: Tracking Cash and Reading Statements

Accounting tracks every dollar in and out with a running balance, summarizes performance on an income statement and position on a balance sheet, and builds trust only when it is honest.

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Key things to remember

  1. 1Financial accounting reports to outsiders (lenders, investors, government); management accounting helps insiders make decisions.
  2. 2Ending cash = opening cash + cash in − cash out. The last running balance must match.
  3. 3Net income = revenue − expenses. Owner investments and loans are not revenue; loan repayments and long-lasting equipment are not expenses.
  4. 4Assets = liabilities + owner's equity, and the balance sheet must balance.
  5. 5Profit margin = net income ÷ revenue × 100%.
  6. 6Cash on hand is not the same as profit, and every report must be honest, complete and backed by records.

At the end of September, Maya has $633 in her Class Act Hoodies account. Did she make $633 in profit? No, and if she thinks so, she might spend money she does not really have. Some of that cash was her own savings, some was a loan she has to pay back, and some was spent on a heat press she will use for years. Accounting is the business function that records, sorts and reports the money side of a business so that the owner, and anyone else who needs to know, can see what is really going on.

Two kinds of accounting, one goal: trust

AFinancial accounting
  • For people outside the business: lenders, investors, the government (for taxes)
  • Reports what already happened, in standard statements
  • Must follow agreed rules so outsiders can compare businesses
  • Example: the statements Maya shows the parent who lent her money
BManagement accounting
  • For people inside the business: owners and managers
  • Helps make decisions about the future
  • Any format that is useful: cost per unit, budgets, forecasts
  • Example: working out whether a $36 team price still makes a profit

Both kinds build transparency, meaning people can see how the money moved, and transparency builds trust. A lender who can see clear, honest records is more willing to lend again. A customer who knows a business pays its suppliers and taxes is more willing to buy. Hiding or twisting the numbers might look good for a month, but once trust is broken it is very hard to win back.

Tracking cash in and cash out

The simplest accounting record is a cash ledger: a list of every time money comes in (a cash inflow) or goes out (a cash outflow), in date order, with a running balance that shows how much cash is left after each one. Every entry needs a date, a description and an amount, and it should be backed up by a receipt or a record of the sale.

Cash in (inflows)Cash out (outflows)SalesOwner investmentLoansSuppliesRentWagesLoan repaymentCash balancein − out, kept runningNew balance = old balance + cash in − cash outWeekDescriptionCash inCash outBalanceStarting balance$01Owner investment$300$3001Loan from family$200$5001Supplies (beads, cord)$180$3202Sales at school market$240$5602Booth rent$60$5003Sales at school market$320$8203Wages for a helper$90$7304Loan repayment$50$680Totals$1,060$380$680Check: $0 + $1,060 − $380 = $680 ending balance
Fig 1Cash inflows add to the running balance and cash outflows subtract from it.
DateDescriptionCash inCash outBalance
Sep 1Maya invests her savings$500$500
Sep 2Loan from a parent$300$800
Sep 3Buy heat press$300$500
Sep 4Buy 18 blank hoodies at $18$324$176
Sep 5Buy vinyl: 18 hoodies at $3 each (old process)$54$122
Sep 12Sales: 10 hoodies at $40$400$522
Sep 19Sales: 8 hoodies at $40$320$842
Sep 20Helper wages (6 hours)$120$722
Sep 26Paper mailers$9$713
Sep 28Social media ads$30$683
Sep 30Repay part of the loan$50$633
Totals$1,520$887$633
Class Act Hoodies' cash ledger for September. The vinyl was bought before the process improvements, at the old $3 per hoodie (18 × $3 = $54).
Check: 0 + 1,520 - 887 = 633, which matches the last running balance. If they do not match, there is a mistake to find.
Loading interactive…
Add inflows and outflows month by month and watch the running cash balance. Try to find the month where cash would run out.

The income statement and the balance sheet

The ledger shows every cash movement, but it mixes very different things together. Two simple statements sort them out. The income statement shows performance over a period: did the business earn more than it spent to run? Revenue is money earned from selling. Expenses are the costs used up to earn that revenue. Revenue minus expenses is net income (profit), or a net loss if expenses are bigger.

  • Owner investment is NOT revenue. Maya's $500 is her own money going in, not money earned from customers.
  • A loan is NOT revenue. The $300 must be paid back. Repaying it is NOT an expense either.
  • The heat press is NOT an expense this month. It will be used for years, so it is an asset: something the business owns that has value.
Class Act Hoodies: Income Statement, month ended September 30Amount
Revenue: sales (18 hoodies at $40)$720
Expenses: blank hoodies$324
Expenses: vinyl$54
Expenses: paper mailers$9
Expenses: helper wages$120
Expenses: advertising$30
Total expenses$537
Net income$183
Revenue $720 minus expenses $537 equals net income $183.

The balance sheet shows position on one day: what the business owns (assets), what it owes to others (liabilities), and what belongs to the owner (owner's equity). The two sides must always be equal, because everything the business owns was paid for either by someone it owes or by the owner.

Class Act Hoodies: Balance Sheet, September 30Amount
Assets: cash$633
Assets: heat press$300
Total assets$933
Liabilities: loan owed to parent ($300 − $50)$250
Owner's equity: Maya's investment $500 + net income $183$683
Total liabilities and owner's equity$933
Both sides total $933, so the balance sheet balances.
Income StatementGlow Co. candles · for the term ended June 30RevenueSales$1,200ExpensesMaterials used$420Booth rent$120Advertising$60Packaging$80Total expenses$680Net income$520Balance SheetGlow Co. candles · as at June 30AssetsCash$690Inventory (unsold candles)$90Equipment (moulds, melter)$120Total assets$900LiabilitiesLoan from family$180Owner’s equityOwner’s investment$200Net income for the term$520Total owner’s equity$720Total liabilities + equity$900Revenue − expenses = net income$1,200 − $680 = $520, added to equity →Check: Assets $900 = Liabilities $180 + Owner’s equity $720
Fig 2How the income statement's net income flows into owner's equity on the balance sheet. The example shown is a student candle venture.
VideoFocus on what the income statement and the balance sheet each show and why profit is not the same as cash in the bank.Watch on YouTube

Reading the statements and reporting honestly

  • Profit margin shows how much of each sales dollar is profit: . For Class Act Hoodies: , so about 25 cents of every dollar of sales is profit.
  • Cash on hand shows whether bills can be paid now. $633 easily covers next month's $50 loan payment and a new hoodie order.
  • Owner's equity grew from $500 to $683, because the profit stays in the business.
  • Liabilities fell from $300 to $250, which lenders like to see.
Cash is not the same as profit
Class Act Hoodies has $633 of cash but only $183 of profit. The rest of the cash came from Maya's savings and the loan, minus the press and the loan repayment. Spending cash as if it were all profit is one of the fastest ways a small business gets into trouble.
The responsibility to report honestly
Every number in a report should be true, complete and backed by a receipt or sales record. Do not leave out expenses to make profit look bigger, do not count a loan as sales, and do not mix personal spending with business spending. Lenders, investors, partners and the government rely on these numbers, and in Canada a business must keep records and report its income for taxes.

Worked examples

Reveal one step at a time and try to beat it to the next line.

Example 1
Class Act Hoodies starts October with $633. During October, cash in is $880 of sales and cash out is $468 for hoodies, $60 for vinyl, $160 for wages and $50 for a loan payment. Find the ending cash balance.
Example 2
Using Class Act Hoodies' September ledger, build the income statement. Decide which ledger lines are revenue, which are expenses, and which belong on neither.
Example 3
Build Class Act Hoodies' balance sheet at September 30 and check that it balances.
Example 4
Judge Class Act Hoodies' September performance and position using its profit margin and cash on hand.

Where marks get lost

  • Counting owner investments or loans as revenue, which makes profit look far bigger than it is.
  • Recording a long-lasting purchase like a heat press as an expense in one month, which makes that month look like a loss.
  • Treating a loan repayment as an expense. It reduces what you owe, not your profit.
  • Thinking the cash balance equals profit and spending it all.
  • Forgetting to add net income to owner's equity, so the balance sheet does not balance.

Flashcards 8

Financial accounting
Management accounting
Cash inflow / cash outflow
Running balance
+ 4 more

Practice

1
A venture starts the week with $240, receives $310 from sales, and pays $185 for supplies and $45 for ads. What is the ending cash balance, in dollars?
$
2
A dog-walking venture earns $1,150 in revenue and has $420 of expenses. What is its net income, in dollars?
$
3
A venture has revenue of $2,000 and net income of $350. What is its profit margin, as a percent to one decimal place?
%
4
A business has assets of $4,800 and liabilities of $1,300. What is the owner's equity, in dollars?
$
5
Which of these would appear as revenue on Class Act Hoodies' income statement?
6
Match each user to the kind of accounting information they mainly use.
A bank deciding whether to lend
The owner deciding on a team discount
The government collecting income tax
A manager comparing two suppliers' costs
7
Sort these into the order they are built, from first to last.
  1. 1Total revenue and expenses for the month
  2. 2Add net income to owner's equity on the balance sheet
  3. 3Calculate net income
  4. 4Record each cash inflow and outflow in the ledger
8
Maya leaves the $120 of helper wages off her income statement so the lender sees a bigger profit. What is the main problem?
9
Is a loan repayment an expense? Answer yes or no.

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