Financial statements

Jambo! Welcome to the Heart of Business: Financial Statements

Habari student! Ever wondered how the owner of that busy duka in your estate, or a big company like Safaricom, really knows if they are making money or just being busy? How do they get a loan from Equity Bank or report to the KRA? The secret is in their "business report card," and today, you're going to learn how to read and create it. These report cards are officially called Financial Statements.

Think of them as the language of business. Once you understand them, you have a superpower! You can understand the health and performance of any business, from your friend's new online shop to the biggest companies on the Nairobi Securities Exchange. Let's dive in!

Image Suggestion: A vibrant, modern classroom in Kenya with a diverse group of students eagerly listening to a charismatic teacher pointing at a whiteboard. The whiteboard has simplified diagrams of the three financial statements (Income Statement, Balance Sheet, Cash Flow). The style should be bright and optimistic.

So, What Exactly are Financial Statements?

Financial Statements are formal, structured reports that show a business's financial activities and position. They are used by various people (we call them stakeholders) to make important decisions.

• Owners/Managers: To see if the business is profitable and to plan for the future.
• Investors: Like your chama or a Sacco, to decide if the business is a good investment.
• Banks & Lenders: To decide whether to give the business a loan.
• The Government (KRA): To determine the amount of tax the business should pay.

There are three main statements we will focus on. Let's call them "The Big Three."

1. The Income Statement (The "Movie" of Your Business)

The Income Statement, also known as the Statement of Profit or Loss, tells you how much profit or loss a business has made over a period of time (like a month, a quarter, or a year). Think of it like a movie – it shows the story of the business's performance from a start date to an end date.

Its main goal is to arrive at the Net Profit, also famously known as "the bottom line."

• Revenue (or Sales): All the money the business earned from selling its goods or services.
• Cost of Goods Sold (COGS): The direct cost of the items that were sold. If you sell sodas, it's what you paid for those specific sodas.
• Gross Profit: This is Revenue minus COGS. It's the profit before you consider other operating expenses.
• Operating Expenses: All other costs to run the business, like rent, salaries, electricity (that KPLC bill!), and marketing.
• Net Profit: The final profit after all expenses have been subtracted from the revenue. This is what everyone wants to see!

Example: Mama Benta's Duka
Mama Benta runs a successful duka. In the month of July, she made sales of Ksh. 150,000. The goods she sold cost her Ksh. 90,000. She also paid Ksh. 10,000 for rent, Ksh. 5,000 for her assistant's salary, and Ksh. 2,000 for electricity. What is her net profit?

Let's calculate it step-by-step:

### Mama Benta's Duka - Income Statement ###
### For the Month Ended 31st July        ###

Revenue (Sales)                          Ksh. 150,000
Less: Cost of Goods Sold (COGS)         (Ksh. 90,000)
----------------------------------------------------
Gross Profit                           Ksh. 60,000

Less: Operating Expenses
  Rent                                  (Ksh. 10,000)
  Salary                                (Ksh. 5,000)
  Electricity                           (Ksh. 2,000)
----------------------------------------------------
Net Profit (The Bottom Line)         Ksh. 43,000

Sawa! Mama Benta made a solid profit of Ksh. 43,000 in July.

2. The Balance Sheet (The "Snapshot" of Your Business)

The Balance Sheet, also known as the Statement of Financial Position, is different. It's not a movie; it's a snapshot. It shows what a business owns and what it owes at a single point in time (e.g., "as at 31st December").

The Balance Sheet is built on one golden rule, the fundamental Accounting Equation. It must always, always, always balance!

    Assets = Liabilities + Owner's Equity

Let's break that down:

• Assets: Economic resources the business owns. Think of cash in the M-Pesa till, the stock on the shelves (inventory), a delivery motorbike, or the shop building itself.
• Liabilities: What the business owes to others. This could be a loan from a Sacco, money owed to a supplier (like the bread company that delivers on credit), or unpaid bills.
• Owner's Equity: The owner's claim on the assets. It's what is left for the owner after you pay off all the liabilities. It represents the owner's investment in the business.

Imagine a weighing scale. It must always be balanced.

          The Accounting Scale
      +===========================+
      |                           |
      |          ASSETS           |      LIABILITIES
      | (What you OWN)            |   + (What you OWE to others)
      |                           |
     /|\                          |      OWNER'S EQUITY
    / | \                         |   + (What you OWE to the owner)
   /  |  \                        |
  +---+---+                       +--------------------------+

Example: Juma's Boda-Boda Business
As at August 1st, Juma has a motorbike worth Ksh. 80,000. He has Ksh. 10,000 cash from his fares. He took a loan of Ksh. 30,000 from his chama to help buy the bike. Let's create his balance sheet.

### Juma's Boda-Boda - Balance Sheet ###
### As at 1st August                 ###

ASSETS
Cash                                  Ksh. 10,000
Motorbike (Equipment)                 Ksh. 80,000
-------------------------------------------------
Total Assets                        Ksh. 90,000

LIABILITIES & EQUITY
Liabilities:
  Chama Loan                          Ksh. 30,000
Owner's Equity:
  Juma's Capital                      Ksh. 60,000
-------------------------------------------------
Total Liabilities & Equity          Ksh. 90,000

See how it balances? Assets (90,000) = Liabilities (30,000) + Equity (60,000). Perfect!

3. The Statement of Cash Flows (The "M-Pesa Statement")

This statement is super important! It tracks the movement of actual cash in and out of the business over a period. Why is this needed? Because profit is not the same as cash!

Think about it: You could sell goods worth Ksh. 50,000 on credit. Your Income Statement shows a profit, but you have no cash in hand to pay your rent! This is a cash flow problem. The Statement of Cash Flows helps you see these issues.

It breaks down cash movements into three areas:

• Operating Activities: Cash from your main business activities (like Mama Benta receiving cash from customers and paying her suppliers).
• Investing Activities: Cash used to buy or sell long-term assets (like Juma buying his motorbike or selling an old one).
• Financing Activities: Cash from owners or lenders (like Juma getting the chama loan or an owner putting more of their own money into the business).

How They All Connect

The Big Three are not islands; they are a family! They talk to each other and are beautifully interconnected.

+------------------+         +------------------+
| INCOME STATEMENT |         |      CASH FLOW   |
|   (The Movie)    |         |    STATEMENT     |
+------------------+         +------------------+
         |                             |
         | Net Profit moves to...      | Ending Cash becomes...
         |                             |
         v                             v
+------------------------------------------------+
|               BALANCE SHEET                    |
|                (The Snapshot)                  |
|  Assets  =  Liabilities  +  Equity           |
|  (Cash)                             |
+------------------------------------------------+

• The Net Profit from the Income Statement increases the Owner's Equity on the Balance Sheet. (A profitable business makes the owner's stake more valuable).
• The ending Cash balance from the Statement of Cash Flows is the same cash figure you see under Assets on the Balance Sheet.

Image Suggestion: A clean, modern graphic illustrating the relationship between the three financial statements. An arrow from the 'Net Income' of an Income Statement points to the 'Equity' section of a Balance Sheet. Another arrow from the 'Ending Cash' of a Cash Flow Statement points to the 'Cash' asset on the Balance Sheet. Use bright, engaging Kenyan-flag inspired colours like green, red, and black with white accents.

You've Got This!

Whew, that was a lot! But don't worry. This is the foundation of accounting. Understanding these three statements—the Income Statement (performance movie), the Balance Sheet (financial snapshot), and the Statement of Cash Flows (the M-Pesa statement)—is your first big step to becoming an accounting expert.

Keep practicing, keep asking questions, and soon you'll be reading business finances like a pro. Hongera! You are on your way.