Financial Statements — The Big Picture

It is the last day of March. The financial year has ended. Rawat Aunty sits in Sharma Sir's office, looking nervous. "Sharma Sir, my husband keeps asking — is the shop making money? Or are we just busy for nothing?" Sharma Sir turns to Meera. "This is the moment everything comes together. All year, you recorded vouchers, wrote journal entries, posted to ledgers, prepared trial balances. Now we answer the only question that truly matters — is the business making money, and how healthy is it?" He places three blank sheets on the desk. "Today, Meera, you will prepare three statements: the Trading Account, the Profit & Loss Account, and the Balance Sheet."

Why Financial Statements Matter

Imagine you have been walking all day through the hills near Bageshwar. You are tired. You have been counting your steps, tracking the path, watching the markers. But at some point, you stop and look around. You ask: "How far have I come? Where am I now?"

Financial statements are that moment of stopping and looking around.

All year long, the journal records every step. The ledger organizes the steps by path. The trial balance checks the count. But the financial statements tell you the result of all those steps.

They answer two big questions:

1. Did the business make a profit or a loss? → This is answered by the Trading Account and Profit & Loss Account.
2. What does the business own and owe right now? → This is answered by the Balance Sheet.

Rawat Aunty does not care about journal entries or ledger postings. She cares about these two questions. And so does every business owner, bank manager, tax officer, and investor.

The Three Statements

For a small trading business like Rawat General Store, we prepare three statements at the end of the year:

The Trading Account feeds into the Profit & Loss Account. The Profit & Loss Account feeds into the Balance Sheet. They are connected like links in a chain.

Part 1: The Trading Account

The Trading Account answers a simple question: Did the shop make money by selling goods for more than they cost?

If Rawat Aunty buys rice for Rs. 40 per kg and sells it for Rs. 50 per kg, she makes Rs. 10 per kg. That Rs. 10 is called gross profit.

The Formula

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

Let us understand each part.

Net Sales = Total Sales - Sales Returns (goods returned by customers)

Cost of Goods Sold (COGS) = Opening Stock + Purchases + Direct Expenses - Closing Stock

• Opening Stock = The goods that were already in the shop at the start of the year.
• Purchases = All goods bought during the year (minus any purchase returns).
• Direct Expenses = Expenses directly related to getting the goods ready for sale (freight, carriage, loading/unloading).
• Closing Stock = The goods still unsold at the end of the year.

Think of it this way: you started with some goods, you bought more goods, you spent money bringing those goods to the shop. That is your total cost. But not everything was sold — some goods are still sitting on the shelves. So you subtract the closing stock.

Trading Account Format

         Trading Account of Rawat General Store
            for the year ending 31st March 2026

 ─────────────────────────────────────────────────────────
    Dr. (Expenses/Costs)     |   Cr. (Revenue/Income)
 ─────────────────────────────────────────────────────────
 Particulars        | Amt(Rs)| Particulars       | Amt(Rs)
 ─────────────────────────────────────────────────────────
 To Opening Stock   | 45,000 | By Sales          |4,80,000
 To Purchases       |2,85,000| Less: Returns     |  (5,000)
 Less: Returns      | (3,000)| Net Sales         |4,75,000
 Net Purchases      |2,82,000|                   |
 To Carriage Inward |  8,000 | By Closing Stock  | 52,000
 To Freight         |  5,000 |                   |
                    |        |                   |
 To Gross Profit    |        |                   |
   (transferred to  |        |                   |
    P&L Account)    |1,87,000|                   |
 ─────────────────────────────────────────────────────────
 Total              |5,27,000| Total             |5,27,000
 ─────────────────────────────────────────────────────────

Reading the numbers:

Rawat Aunty started the year with Rs. 45,000 worth of goods on her shelves (opening stock). During the year, she bought goods worth Rs. 2,85,000 and returned Rs. 3,000 worth (damaged goods). She spent Rs. 8,000 on carriage (transport) and Rs. 5,000 on freight to get goods to her shop.

Total cost side = Rs. 45,000 + Rs. 2,82,000 + Rs. 8,000 + Rs. 5,000 = Rs. 3,40,000.

Her total sales were Rs. 4,80,000, minus Rs. 5,000 in sales returns = Rs. 4,75,000 net sales. At year-end, Rs. 52,000 worth of goods were still unsold (closing stock).

Total income side (before gross profit) = Rs. 4,75,000 + Rs. 52,000 = Rs. 5,27,000.

Gross Profit = Rs. 5,27,000 - Rs. 3,40,000 = Rs. 1,87,000.

This means Rawat Aunty made Rs. 1,87,000 just from buying and selling goods — before paying rent, salary, electricity, and other expenses.

Meera explains it to Rawat Aunty in simple words:

"Aunty, for every Rs. 100 of goods you sold, about Rs. 60 was the cost of the goods, and Rs. 40 was your margin. That margin is the gross profit."

Part 2: The Profit & Loss Account

The gross profit is not the final answer. Rawat Aunty still has to pay rent, salary, electricity, and many other expenses. The Profit & Loss (P&L) Account shows what is left after ALL expenses.

The Formula

Net Profit = Gross Profit + Other Income - All Indirect Expenses

• Gross Profit comes from the Trading Account.
• Other Income = Income not from selling goods (interest earned on bank deposits, commission received, etc.).
• Indirect Expenses = Expenses not directly related to goods (rent, salary, electricity, stationery, insurance, depreciation, etc.).

Profit & Loss Account Format

      Profit & Loss Account of Rawat General Store
           for the year ending 31st March 2026

 ─────────────────────────────────────────────────────────
    Dr. (Expenses)              |   Cr. (Income)
 ─────────────────────────────────────────────────────────
 Particulars          | Amt(Rs)| Particulars       | Amt(Rs)
 ─────────────────────────────────────────────────────────
 To Salary            | 48,000 | By Gross Profit   |1,87,000
 To Rent              | 60,000 |   (from Trading)  |
 To Electricity       | 14,400 | By Interest on    |
 To Telephone         |  3,600 |   Bank Deposit    |  2,400
 To Stationery &      |        | By Commission     |
   Printing           |  2,000 |   Received        |  1,500
 To Repair &          |        |                   |
   Maintenance        |  5,000 |                   |
 To Insurance         |  3,000 |                   |
 To Depreciation on   |        |                   |
   Furniture          |  2,500 |                   |
 To Miscellaneous     |        |                   |
   Expenses           |  4,000 |                   |
                      |        |                   |
 To Net Profit        |        |                   |
   (transferred to    |        |                   |
    Capital Account)  | 48,400 |                   |
 ─────────────────────────────────────────────────────────
 Total                |1,90,900| Total             |1,90,900
 ─────────────────────────────────────────────────────────

Reading the numbers:

Total indirect expenses = Rs. 48,000 + Rs. 60,000 + Rs. 14,400 + Rs. 3,600 + Rs. 2,000 + Rs. 5,000 + Rs. 3,000 + Rs. 2,500 + Rs. 4,000 = Rs. 1,42,500.

Total income = Gross Profit Rs. 1,87,000 + Interest Rs. 2,400 + Commission Rs. 1,500 = Rs. 1,90,900.

Net Profit = Rs. 1,90,900 - Rs. 1,42,500 = Rs. 48,400.

Meera turns to Rawat Aunty:

"Aunty, after paying everyone — Kamla's salary, the landlord's rent, the electricity board, everything — your shop made a net profit of Rs. 48,400 this year."

Rawat Aunty beams. "So we ARE making money! Not just running around for nothing."

Sharma Sir adds: "Rs. 48,400 in a year. That is about Rs. 4,000 per month profit. It is decent for a small kirana shop. But look at the numbers carefully — rent alone is Rs. 60,000. That is your biggest expense. If you could negotiate lower rent, your profit would jump."

This is the power of financial statements. They do not just show profit. They show where the money is going.

What Each Expense Means

Let Meera explain each line item so Rawat Aunty understands:

Part 3: The Balance Sheet

The P&L Account tells you about the year — how much money came in and went out. The Balance Sheet tells you about a single moment in time — what does the business own and owe on this exact date?

The Accounting Equation

The Balance Sheet is built on one equation:

Assets = Liabilities + Capital (Owner's Equity)

This equation must ALWAYS be true. It is like saying: "Everything the business owns was funded either by borrowing (liabilities) or by the owner's investment (capital)."

Think of it this way. Rawat Aunty's shop has shelves, stock, cash, and a bank balance. Where did the money for all of this come from? Either from Rawat Aunty herself (capital), or from suppliers she has not yet paid (creditors/liabilities).

Balance Sheet Format

         Balance Sheet of Rawat General Store
               as on 31st March 2026

 ─────────────────────────────────────────────────────────
   Liabilities & Capital     |        Assets
 ─────────────────────────────────────────────────────────
 Particulars        | Amt(Rs)| Particulars        | Amt(Rs)
 ─────────────────────────────────────────────────────────
                    |        |                    |
 Capital Account    |        | Fixed Assets       |
   Opening Balance  |2,00,000|   Furniture        | 25,000
   Add: Net Profit  |  48,400|   Less: Depreciation| (2,500)
   Less: Drawings   | (36,000)|  Net Furniture    | 22,500
   Closing Capital  |2,12,400|                    |
                    |        | Current Assets     |
 Current Liabilities|        |   Closing Stock    | 52,000
   Sundry Creditors | 35,000 |   Sundry Debtors  | 28,000
   Outstanding      |        |   Cash in Hand     | 15,400
     Expenses       |  4,500 |   Cash at Bank     | 78,000
                    |        |   Prepaid Insurance |  1,000
                    |        |   Interest Accrued  |    500
                    |        |                    |
 Loan (Long-term)   |        |                    |
   Bank Loan        | 45,500 |                    |
                    |        |                    |
 ─────────────────────────────────────────────────────────
 Total              |2,97,400| Total              |2,97,400
 ─────────────────────────────────────────────────────────

Let us break this down in plain language.

The Left Side: Liabilities and Capital

Capital Account:

• Rawat Aunty started the year with Rs. 2,00,000 as her investment in the business.
• The shop earned Rs. 48,400 net profit. This profit belongs to the owner, so it is added to capital.
• During the year, Rawat Aunty withdrew Rs. 36,000 for personal use (drawings). This reduces her capital.
• Closing capital = Rs. 2,00,000 + Rs. 48,400 - Rs. 36,000 = Rs. 2,12,400.

Current Liabilities:

• Sundry Creditors (Rs. 35,000): Money owed to suppliers for goods purchased on credit.
• Outstanding Expenses (Rs. 4,500): Expenses that have been incurred but not yet paid (like December electricity bill not yet paid by March 31).

Bank Loan (Rs. 45,500): A long-term loan taken from the bank for shop improvement.

Total Liabilities + Capital = Rs. 2,12,400 + Rs. 35,000 + Rs. 4,500 + Rs. 45,500 = Rs. 2,97,400.

The Right Side: Assets

Fixed Assets:

• Furniture: Original cost Rs. 25,000, minus Rs. 2,500 depreciation = Rs. 22,500 net value.
• Fixed assets are things the business uses for a long time — they are not for sale.

Current Assets:

• Closing Stock (Rs. 52,000): Goods still unsold on the shelves.
• Sundry Debtors (Rs. 28,000): Money owed by customers who bought on credit.
• Cash in Hand (Rs. 15,400): Cash in the shop's cash box.
• Cash at Bank (Rs. 78,000): Balance in SBI account.
• Prepaid Insurance (Rs. 1,000): Insurance paid in advance for next year.
• Interest Accrued (Rs. 500): Interest earned on bank deposit but not yet received.

Total Assets = Rs. 22,500 + Rs. 52,000 + Rs. 28,000 + Rs. 15,400 + Rs. 78,000 + Rs. 1,000 + Rs. 500 = Rs. 2,97,400.

Assets (Rs. 2,97,400) = Liabilities + Capital (Rs. 2,97,400)

The equation balances!

What the Numbers Tell Rawat Aunty

Meera sits with Rawat Aunty and explains the Balance Sheet in everyday language:

"Aunty, here is what your shop looks like right now:"

"Your shop owns things worth Rs. 2,97,400 in total — furniture, stock on shelves, money in the cash box, money in the bank, and money that customers owe you."

"Out of this, Rs. 35,000 is owed to your suppliers. Rs. 4,500 is owed in unpaid bills. Rs. 45,500 is a bank loan. So these are other people's money that is currently in your business."

"The rest — Rs. 2,12,400 — is YOURS. That is your capital. Your ownership in the business."

Rawat Aunty thinks about this. "So if I closed the shop today, sold everything, paid everyone I owe, I would be left with about Rs. 2,12,400?"

"Roughly, yes," Meera says. "Though selling stock quickly might mean you get less than Rs. 52,000 for it. And some debtors might not pay. But that is the basic idea."

How the Three Statements Connect

Here is the flow:

  Trading Account          Profit & Loss Account         Balance Sheet
  ───────────────          ─────────────────────         ──────────────
  Sales - COGS             Gross Profit                  Net Profit
       ↓                   + Other Income                    ↓
  = Gross Profit  ────→    - Indirect Expenses           Added to
                                ↓                        Capital Account
                           = Net Profit  ────────→       on Balance Sheet

1. The Trading Account gives you Gross Profit.
2. Gross Profit flows into the Profit & Loss Account, which gives you Net Profit.
3. Net Profit flows into the Balance Sheet, where it is added to the owner's Capital.

They are not three separate reports. They are one continuous story.

Common Terms Meera Should Know

Quick Recap

• Trading Account shows Gross Profit = Sales - Cost of Goods Sold.
• Cost of Goods Sold = Opening Stock + Net Purchases + Direct Expenses - Closing Stock.
• Profit & Loss Account shows Net Profit = Gross Profit + Other Income - Indirect Expenses.
• Balance Sheet shows the financial position: Assets = Liabilities + Capital.
• Net Profit is added to Capital on the Balance Sheet. Drawings are subtracted from Capital.
• Fixed Assets are used in the business long-term. Current Assets change frequently.
• Current Liabilities are due within a year. Long-term Liabilities are due later.
• The three statements are connected — Trading feeds P&L, P&L feeds the Balance Sheet.
• These statements answer the ultimate questions: "Is the business profitable?" and "What is the business worth?"

Practice Exercise — Try This Yourself

Prepare the Trading Account, Profit & Loss Account, and Balance Sheet for a small shop called "Pahadi Provisions" using the following information for the year ending 31st March 2026:

Given Information:

Steps:

1. Prepare the Trading Account and find Gross Profit.
2. Prepare the Profit & Loss Account and find Net Profit.
3. Prepare the Balance Sheet and verify that Assets = Liabilities + Capital.

Hint for Gross Profit:

• Net Sales = 3,20,000 - 3,000 = 3,17,000
• COGS = 30,000 + (2,00,000 - 2,000) + 5,000 - 35,000 = 1,98,000
• Gross Profit = 3,17,000 - 1,98,000 = 1,19,000

Fun Fact

In India, the financial year runs from April 1st to March 31st. But do you know why? When the British ruled India, they brought their financial year system. But Britain itself changed to January-December later. India kept April-March because it aligns with the harvest cycles — the Rabi crop comes in around March-April, which was when merchants and landowners settled their accounts. So the Indian financial year is actually connected to the farming seasons of our land. When Rawat Aunty closes her books on March 31st, she is following a tradition tied to the agricultural rhythm of India.

In the next chapter, Meera learns about the Chart of Accounts — the organized master list of all accounts a business uses. It is like creating a map before starting a journey.