Preparing financial business statements

Tools to use

Among the Business Tools is a sample balance sheet. This spreadsheet can be used multiple times.

For more detailed information on balance sheets and other financial statements, read more about financial statements.

Preparing an income statement

Also called a profit and loss statement, or a "P&L," an income statement lists your income, expenses and net income (or loss). The net income (or loss) is equal to your income minus your expenses. Your business's tax return will use a variation of the income statement to determine your potentially taxable income.

The income statement is prepared after all adjusting entries are made in the general journal, all journal entries have been posted to the general ledger, the general ledger accounts have been footed to arrive at the period end totals, and an adjusted trial balance has been prepared from the general ledger totals.

Like financial statements, don't include cents on your income statements that might look something like this:

Tools to use

In the Business Tools area is a sample income statement for your use. This spreadsheet can be used multiple times.

Prepare closing entries to get the books ready for the next accounting period

After financial statements are prepared, don't sit on the beach with a pina colada just yet. You need to get your books ready for the next accounting period by clearing out the income and expense accounts in the general ledger and transferring the net income (or loss) to your owner's equity account. This is done by preparing closing entries in the general journal.

The steps to closing the books

Note the distinction between adjusting entries and closing entries. Adjusting entries are required to update certain accounts in your general ledger at the end of an accounting period. They must be done before you can prepare your financial statements and income tax return. Closing entries are needed to clear out your revenue and expense accounts as you start the beginning of a new accounting period.

Preparing your closing entries is a very simple, mechanical process. Follow these steps:

1. Close the revenue accounts. Prepare one journal entry that debits all the revenue accounts. (These accounts will have a credit balance in the general ledger prior to the closing entry.) Credit an account called "income summary" for the total.
2. Close the expense accounts. Prepare one journal entry that credits all the expense accounts. (These accounts will have a debit balance in the general ledger prior to the closing entry.) Debit the income summary account for the total.
3. Transfer the income summary balance to a capital account. Prepare a journal entry that clears out the income summary account. This entry effectively transfers the net income (or loss) of the business to the owner's equity account.
4. Close the drawing account. If your business is a sole proprietorship or partnership, close the drawing accounts (if any) by preparing a journal entry that credits the drawing account and debits the owner's equity account.

Example

You have finalized your general ledger and prepared a balance sheet and income statement for the year ended December 31, 2011. You want to get your books ready for next year. You prepare the four closing entries as follows:

After all closing entries are made, post the entry totals to the general ledger. Foot the general ledger accounts to arrive at the beginning amounts for the new accounting period. All revenue and expense accounts should have a zero balance.