Financial statements

Habari Mwanafunzi! Welcome to the World of Financial Statements!

Ever wondered how the owner of your local duka knows if they are making money? Or how big companies like Safaricom can tell their story to investors? It’s not magic, it’s Accounting! And the secret language they use is called Financial Statements.

Think of financial statements as a business's school report card. They show its performance (did it pass with flying colours?), its health (is it strong and stable?), and its potential. Today, we are going to learn how to read and understand this report card. Let's get started!

The Report Card for Profit: The Income Statement

The first and most common report is the Income Statement. In the Kenyan system, we often learn it as the Trading, Profit and Loss Account. Its main job is to answer one simple question: "Did the business make a profit or a loss during a certain period?" (like a month or a year).

It’s a story told in two parts.

Part 1: The Trading Account - The Gross Profit

This part focuses on the main business activity – buying and selling goods. It helps us calculate the Gross Profit, which is the profit made from just selling goods before considering other operational expenses like rent or salaries.

• Sales (Revenue): The total money received from selling goods.
• Cost of Goods Sold (COGS): What it cost you to get the goods you sold.

The formula for Gross Profit is straightforward:

Gross Profit = Sales - Cost of Goods Sold (COGS)

To find the COGS, we use this little calculation:

COGS = Opening Stock + Purchases - Closing Stock

Part 2: The Profit and Loss Account - The Net Profit

Once we have our Gross Profit, we need to see what's left after paying all the other bills. This gives us the Net Profit – the real, final profit!

• Expenses: The costs of running the business, like rent, salaries, electricity bills from KPLC, and even M-Pesa transaction fees.
• Other Incomes: Any extra money the business made that wasn't from its main sales (e.g., earning commission).

The formula for Net Profit is:

Net Profit = Gross Profit + Other Incomes - Expenses

Example Scenario: "Maria's Maandazi Corner"

Maria runs a popular maandazi stand in her neighbourhood. At the end of the month, she wants to know if she made a profit. Here are her numbers:

• Total Maandazi Sales: KSh 20,000
• Flour, Sugar, Oil (Purchases): KSh 8,000
• Stock of flour left at month-end (Closing Stock): KSh 1,000
• Rent for her stand: KSh 2,000
• Her own salary: KSh 5,000

Let's prepare her Income Statement!

        MARIA'S MAANDAZI CORNER
        INCOME STATEMENT
        FOR THE MONTH ENDED 31ST MARCH

---------------------------------------------------

Sales                                       20,000
Less: Cost of Goods Sold
  Purchases               8,000
  Less: Closing Stock     (1,000)
                          -------
  Cost of Goods Sold                         (7,000)
                                            --------
GROSS PROFIT                                13,000

Less: Expenses
  Rent                    2,000
  Salary                  5,000
                          -------
  Total Expenses                             (7,000)
                                            --------
NET PROFIT                                   KSh 6,000
                                            ========

Fantastic! Maria made a Net Profit of KSh 6,000. She's doing well!

Image Suggestion:

An uplifting, vibrant digital illustration of a young Kenyan woman like Maria, smiling proudly behind her maandazi stand. The stand is neat, with a sign that says "Maria's Maandazi Corner". In the background, there's a bustling, friendly neighbourhood scene. The style should be colourful and encouraging.

The Snapshot in Time: The Balance Sheet

Our next report is the Balance Sheet, also known as the Statement of Financial Position. If the Income Statement is a video of the year, the Balance Sheet is a single photograph. It shows what a business owns (Assets) and what it owes (Liabilities) on a specific day.

It is all built on one very powerful rule, the Accounting Equation:

          ASSETS   =   LIABILITIES   +   OWNER'S EQUITY (CAPITAL)
    (What the business     (What the business     (The owner's stake/
         OWNS)                 OWES)              investment)

+---------------------+     +------------------------------------------+
|       ASSETS        |  =  |    LIABILITIES   +   OWNER'S EQUITY      |
+---------------------+     +------------------------------------------+

The two sides MUST always balance. Let's break it down:

• Assets (What you OWN):
  • Non-Current Assets: Long-term items that will be used for more than a year. E.g., a building, a delivery truck (Isukuti), a sewing machine for a tailor.
  • Current Assets: Short-term items that will be converted to cash within a year. E.g., Cash in a KCB bank account, M-Pesa float, stock of goods to be sold, money owed by customers (Debtors).
• Liabilities (What you OWE):
  • Non-Current Liabilities: Debts to be paid back in more than one year. E.g., A long-term loan from a SACCO or Equity Bank to start the business.
  • Current Liabilities: Debts to be paid within one year. E.g., Money owed to suppliers (Creditors).
• Owner's Equity (Capital): This is what the owner has personally invested in the business. It represents the owner's claim on the assets of the business.

Example Scenario: Let's check on Maria's business again!

On the 31st of March, this is the financial position of "Maria's Maandazi Corner":

• She has a cooking stove (Jiko) and utensils worth: KSh 5,000
• The stock of flour she has left is worth: KSh 1,000
• Cash in her cash box: KSh 8,000
• She took a small loan from her chama (savings group) to start, and still owes: KSh 2,000
• Her initial investment (Capital) was: KSh 6,000

Let's build her Balance Sheet!

        MARIA'S MAANDAZI CORNER
        BALANCE SHEET
        AS AT 31ST MARCH

---------------------------------------------------
ASSETS
Non-Current Assets
  Equipment (Jiko & Utensils)         5,000

Current Assets
  Stock                               1,000
  Cash                                8,000
                                      -----
Total Current Assets                  9,000
                                      -------
TOTAL ASSETS                         14,000
                                     ========

LIABILITIES & EQUITY
Current Liabilities
  Chama Loan                          2,000

Owner's Equity
  Capital (Opening)       6,000
  Add: Net Profit         6,000  <-- (From Income Statement!)
                          -----
  Capital (Closing)                  12,000
                                     -------
TOTAL LIABILITIES & EQUITY           14,000
                                     ========

Look at that! Total Assets (KSh 14,000) = Total Liabilities & Equity (KSh 14,000). It balances perfectly!

How They All Fit Together

Did you notice the magic link between the two statements? The Net Profit from the Income Statement is a crucial part of the Balance Sheet!

The profit a business makes increases the owner's worth (Equity). This is the most important connection to remember.

+----------------------+
|   INCOME STATEMENT   |
|   (Shows Profit)     |
+----------------------+
          |
          |  (Net Profit of KSh 6,000)
          |
         \/
+----------------------+
|    OWNER'S EQUITY    | ---> This is a section inside the...
| (Profit is added     |
|   to Capital)        |
+----------------------+
          |
         \/
+----------------------+
|     BALANCE SHEET    |
|   (Must Balance)     |
+----------------------+

You've Got This! Your Financial Superpower

Congratulations! You have just learned the language of business. Understanding these two key statements is like having a superpower. You can now look at a business and understand its story.

• The Income Statement tells you if the business is winning (profit) or losing the game over a period of time.
• The Balance Sheet gives you a snapshot of its health – what it owns and what it owes on a single day.

Keep practicing, and soon you'll be able to analyse any business, from the Jua Kali artisan on the corner to the biggest companies in Kenya. Now, go ahead and try creating a simple income statement for a small business you can imagine!