Financial statements are created to provide a report of a business’s overall health. They consist of four parts:
- The income statement which lists the revenues, expenses, and profits/losses generated during the reporting period.
- The balance sheet to show assets, liabilities and equity.
- The statement of cash flows to show how and where cash comes in and out of the business.
- The statement of retained earnings tells the amount of income left in the company after dividends are paid.
If you plan to do some of your own accounting and outsource portions of it, most operators will keep the income statement and balance inhouse, as they are easier to prepare. The statement of cash flows and the statement of retained earnings tend to be more complicated. Under the assumption that the more complicated items will be outsourced, here are some basic terms used in income statement and balance sheet:
*Retained Earnings: Retained earnings are a rolling balance of the company’s net income minus any dividends paid out to stockholders or withdrawals made by the owner. Each time financial statements are prepared, the accountant (or accounting software) will use the previous balance of retained earnings in order to calculate the new balance. The formula for this is:
Beginning Retained Earnings + Net Income – Dividends/Withdrawals = End Retained Earnings
Notice that all accounts are either a “debit” or a “credit”. After you identify which accounts need to be adjusted, you will then need to debit one account and credit the other account. For accounting purposes, a debit generally increases accounts containing what you own, and a credit generally increases accounts containing what others own/what you are still on the hook for.
From a mathematical perspective, think of a debit as adding to an account and a credit as subtracting from an account. Essentially, when you are crediting an account, you are adding a negative number. This is how the accounts balance each other out. When accounts do not balance, that is the first indication that an account was either debited or credited with an incorrect amount.
Examples of accounts that are increased with a debit:
- Dividends (Draws)
Examples of accounts are increased with a credit:
- Owner’s (Stockholder’s) Equity
To decrease an account, you would perform the opposite. For example, if you are decreasing cash, which is an asset, you would be crediting the account.
These accounts should be further broken down into general ledger codes (GL codes) that will serve as the foundation of all accounting transaction. That will be discussed in its own section.
The Ctuit Guide to Restaurant Accounting provides some high-level accounting concepts and best practices for restauranteurs. In this series, we will cover the most basic accounting principles – the ones that you need to know to get a better understanding of how to run a profitable restaurant.
Read the complete series: