How to Prepare Your Financial Statement as a Sole Trader

As a sole trader, knowing how to prepare your financial statement is crucial. Sometimes, you may not have the luxury of an in-house accountant.

Even if you do, you should be able to make sense of the numbers. Otherwise, you will remain in the dark about your business. Such will impair your ability to make sound financial decisions in your enterprise. 

Consider Sam Walton’s autobiography Made In America. Al Johnson, the CEO of Walmart at one time, stated the following about Walmart’s owner and founder:

“Every Friday morning for six years, I would take my columnar pad with all the numbers on it into Sam’s office for him to review. Sam would jot them down on his pad and work through the calculations himself. I always knew I could not just go in there and lay a sheet of numbers in front of him and expect him to just accept it.”

You may already know the importance of preparing your financial statement. However, taking the steps to do it may seem daunting.

In this guide, we’ll break down the process into simple steps. All you have to do is follow our step-by-step process and illustration. In the end, you will have a working knowledge of how to prepare your financial statements as a sole trader.

Key Financial Statement of a Sole Trader

Financial statements are vital tools that offer insights into your business’s performance. It enables you to make informed decisions and meet regulatory requirements.

Without your financial statement, you will make decisions based on feelings. This is a recipe for disaster and one of the reasons businesses fail.

Let’s talk about the key financial statements for a sole proprietorship and how to prepare them. These are the Income Statement, the Balance Sheet, and the Cash Flow Statement.

These three statements work together to give a clear picture of the financial health of your business.

Income Statement: This shows how much money the business made and how much it spent over some time, usually a month, quarter, or year. It includes revenues (money earned) and expenses (money spent). It is otherwise called the Profit and Loss Statement.

The net income represents the excess of revenues over expenses for that period. If expenses exceed revenues, the sole proprietorship incurs a net loss. If the reverse is the case, then, you have your net profit.

Balance Sheet: This gives a snapshot of what the business owns (assets) and what it owes (liabilities) to outsiders at a specific point in time. The balance sheet is like a financial picture of the business at a certain moment.

Cash Flow Statement: A cash flow statement shows the movement of cash within the business. This inflow and outflow of cash is based on 3 sources and categories: operations, investing, and financing.

This is an extremely important financial statement. It gives at a glance, a snapshot of the business’s financial health and reveals the movement of actual cash in the business.

Why “actual” cash? For instance, the income statement uses what is called the accrual basis of accounting. In this case, you calculate money as it is earned but not received yet.

What this means is that an invoice sent to a customer represents sales made even when you have not received a cash payment. You record such sales even if they are on credit. So, the income statement does not reflect cash flow like the cash flow statement.

Also Read: 7 Bookkeeping Strategies that Can Help Your Business in Nigeria

Step-by-Step Framework on How to Prepare Your Financial Statement as a Sole Trader

Here’s a general guide on how to prepare your financial statement as a sole trader. We will illustrate with a fictitious statement of accounts to give you an idea of what each statement looks like. Actual figures will vary based on your business operations and transactions.

Organize Your Financial Records:

Keep track of all your business transactions. This includes proof of income, expenses, assets, and liabilities. Maintain a systematic record-keeping system, either manually or using accounting software.

Income Statement:

List your revenue: Include all income generated by your business, such as sales, service fees, and any other sources of income. Then, deduct your expenses including rent, utilities, salaries, and any other relevant costs. To calculate your net income, subtract your total expenses from your total revenue.

Income Statement for the Year Ended December 31, 2023

Revenue

Sales ₦500,000

Other Income ₦10,000

Total Revenue ₦510,000

Expenses

Cost of Goods Sold ₦200,000

Operating Expenses ₦80,000

Depreciation ₦5,000

Other Expenses ₦15,000

Total Expenses ₦300,000

Net Income ₦210,000

Balance Sheet:

List your assets. This includes cash in hand or cash at the bank, inventory, equipment, and accounts receivable. Accounts receivable is simply the amount owed to your business.

Your fixed assets represent the business “properties” that are not easily convertible to cash within a year such as machinery. Current assets represent assets that are more liquid and can be converted to cash within a year. Your stock or inventory is a current asset. Knowing the value of these assets is one of many reasons why stock-taking is important.

List your liabilities: Include all your business liabilities, such as loans, accounts payable, and other debts. The difference between these assets and liabilities is called owner’s equity. To calculate the owner’s equity, find the difference between your assets and liabilities. This difference represents your interest and stake in the business. It’s the residual value of your business after liabilities are taken from your business. 

Also Read: How to Calculate Value-Added Tax in Nigeria

Balance Sheet as of December 31, 2023

Assets

Current Assets

Cash ₦50,000

Accounts Receivable ₦20,000i

Inventory ₦30,000

Other Current Assets ₦5,000

Total Current Assets ₦105,000

Fixed Assets

Property, Plant & Equipment ₦100,000

Less: Accumulated Depreciation ₦10,000

Net Fixed Assets ₦90,000

Total Assets ₦195,000

Liabilities and Owner’s Equity

Current Liabilities

Accounts Payable ₦15,000

Short-term Loans ₦10,000

Other Current Liabilities ₦5,000

Total Current Liabilities ₦30,000

Long-term Liabilities

Long-term Loans ₦25,000

Other Long-term Liabilities ₦8,000

Total Long-term Liabilities ₦33,000

Owner’s Equity

Capital ₦132,000

Total Owner’s Equity ₦132,000

Total Liabilities and Owner’s Equity ₦195,000

At the end of the financial year, both assets and liability sides must reflect the same amount. Your equity which is your net worth is the amount of capital you invested in your business.

This amount increases when your investment increases or profits. And the greater your equity, the more money is available for other activities like investment. You can get over the stress if you know how to prepare a financial statement as a sole trader.

Cash Flow Statement:

Record your operating activities: Include cash transactions related to your daily business operations. Then, include investing and financing activities. You do this by recording any cash transactions related to investments and financing. Examples are loans or asset purchases.

Cash Flow Statement for the Year Ended December 31, 2023

Operating Activities

Net Income ₦210,000

Adjustments for:

Depreciation ₦5,000

Changes in Working Capital

Increase in Accounts Receivable ₦5,000

Decrease in Inventory ₦2,000

Increase in Accounts Payable ₦2,000

Net Cash from Operating Activities ₦220,000

Investing Activities

Purchase of Property, Plant & Equipment ₦40,000

Other Investing Activities ₦5,000

Net Cash used in Investing Activities ₦45,000

Financing Activities

Repayment of Loans ₦10,000

Owner’s Equity Contribution ₦20,000

Net Cash from Financing Activities ₦10,000

Net Increase in Cash ₦185,000

Beginning Cash Balance ₦50,000

Ending Cash Balance ₦235,000

Shifting to Accounting Software:

Preparing accounting statements means you are familiar with the basics of accounting principles. However, this is rarely the case for most sole proprietors and business owners. 

Equally important is the need to automate your accounting systems. This move is an investment that will make the work much easier for you and your team.

Human errors, time, and cost implications in the long run are some of the reasons you should consider using accounting software to prepare your financial statements.

When you choose the right accounting software, you streamline the process and reduce errors. There are various accounting software options available that can help automate tasks and generate financial statements.

Also Read: The Impact of Tax Evasion and Tax Avoidance in Nigeria’s Economy

Conclusion

The importance of learning how to prepare your financial statement as a sole trader cannot be overstretched. 

Financial statements, like the best budgeting methods, refine your business roadmap. They provide you – the sole trader – with data. Data then translates to information which means guidance and informed decision making.

Your income statement tells you about the profitability of your business. The Balance Sheet shows at a glance your financial position. Your Cash Flow Statement shows cash direction and movement.

As a sole proprietor, basic accounting knowledge will do your business a world of good. Use our illustrations and examples to set up your systems guided by current accounting principles, concepts, and principles in Nigeria.