Question

Anne Marie is the owner of Anne’s Beauty Salon, Inc. Her accountant prepares a monthly financial statement for her business. She doesn’t like to ask him questions about it. She would rather ask you as you are her friend and since she knows that you are taking an accounting course, she asks you the following questions: 1. What does net income mean on the income statement? If I have enough cash at the end of the month then I assume I made money. This concept of net income seems complicated. 2. My accountant told me that the balance sheet shows assets = liabilities plus equity. What does that mean? 3. I don’t understand what the Statement of Retained Earnings is all about. What is retained earnings? How would you respond to each of these questions?

Answer 1

Net income is the amount of money that is arrived after deducting all the operating expenses, preferred dividend, interest and taxes from the total revenue of the company.

It is not necessary that if a person has enough cash at the end of month it means they have made money.

For example, to expand its current production, a profitable company may spend more on investment activities than it generates from operating activities and financing activities. Net cash flow for that period would be negative, although its net income is positive. This means although there is no cash left at the end of the month, there is net income of the company.

Asset is the company resources that the company owns. Liablities are the obligations that the company owes. Assets of a company should be equal to its liablities and equity.

Retained earning is the part of corporations profit that is re-invested rather than being paid out as dividend to the shareholders of the company.