Financial Statements of a Sole Proprietorship
A sole proprietorship prepares two financial statements.
- Statements of Profit or Loss
- Statement of Financial Position
We use a specific period to prepare financial statements. We call this period an “accounting period”. Generally, it is for 12 months.
The financial statements are the output of the accounting process.
Statements of Profit or Loss
We prepare the statement of profit or loss to calculate the operational result of the business. The operational result can be either a profit or a loss. Earlier, the operating result was calculated using an account called ‘Trading and Profit and Loss account‘.
We generally calculate the profit or loss of business in two steps.
- Calculation of gross profit
- Calculation of net profit
Gross profit is the amount of total sales revenue that exceeds the total cost of sales. When calculating gross profit we need to deduct the cost of sales for the total sales revenue of the business. The net profit is calculated by deducting expenses from the sum of gross profit and other income.
Gross profit = Sales revenue – Cost of sales
Net profit = (Gross Profit + other Income) – Expenses
Statement of Financial Position
We prepare the statement of financial position to find out the financial position of a business. In other words, this shows the business’s financial strength and ability. This statement includes the final balances of assets, liabilities, and equity. Therefore this demonstrates the accounting equation of business at the end of an accounting period.
Assets = Equity + Liabilities
This is also known as the balance sheet.