Financial Statements of a Sole Trader
The two statements
A sole trader prepares an income statement (trading and profit and loss account) and a statement of financial position.
Income statement structure
Sales revenue − cost of sales = gross profit. Cost of sales = opening inventory + purchases + carriage inwards − returns outwards − closing inventory. Then deduct expenses to reach net profit. Add other income if any.
Statement of financial position
Non-current assets at net book value, plus current assets (inventory, receivables, prepayments, cash), less current liabilities (payables, accruals, bank overdraft), giving net current assets. Add non-current liabilities, then capital.
The capital section reads: opening capital + net profit + capital introduced − drawings = closing capital. The two halves must agree.
Traps
- Putting carriage inwards in expenses. It is part of the cost of purchases.
- Putting carriage outwards in cost of sales. It is a selling expense.
- Showing drawings as an expense. They reduce capital.
- Forgetting closing inventory in cost of sales and in current assets.
- Including a bank overdraft among current assets.
Worked example
Opening inventory $4,000, purchases $30,000, closing inventory $5,000, sales $50,000. Cost of sales = 4,000 + 30,000 − 5,000 = $29,000. Gross profit = 50,000 − 29,000 = $21,000. If expenses are $9,000, net profit is $12,000. If opening capital was $20,000 and drawings $3,000, closing capital is 20,000 + 12,000 − 3,000 = $29,000.