Financial Statements, Third Edition: A Step-by-Step Guide to Understanding and Creating Financial Reports

Book Preface

The first two editions of this book have sold over 200,000 copies. Not as many books as would be expected for a best-selling novel or a famous (or infamous) politician’s memoir, but that is a lot for an accounting text.

To keep the book timely, we have updated and expanded this new 3rd edition.
I’ve gotten older and wiser in the 20 years since the 1st edition was published, and I’ve tried to add some of that wisdom to this new edition.

The text has been reformatted with spot color for emphasis and clarity. The layout is more attractive and modern.
Tables and charts have been updated and new material added.
Of particular interest is the addition of a discussion of pricing theory. Pricing is more than just guessing, trial and error, or following an old rule of thumb.
This section introduces profit maximization pricing theory based on use of pricevolume curves. AppleSeed Enterprises, Inc.’s applesauce price deliberations are described.

Two new appendixes have been added at the back of the book:
Appendix C. Nonprofit Accounting
—Nonprofit accounting has a different focus than its for-profit cousin. Profit is less important (no taxes to collect) but demonstrating how charitable donations are spent in furtherance of public mission is of great importance. Revenue generation and cost & expense reporting is of interest too. It is documented and available for all (i.e., the public and the government) to see.

Appendix E. Debits and Credits
— Back in the olden days when systematic accounting and statement presentation was first developed, the monks would write down each and every transaction as they occurred. The concept of debits and credits was invented to structure: (a) the layout of accounting journal and ledger books for everyone to understand, (b) to aid the monks in classifying and recording transactions properly, and (c) to catch manual transcribing errors.

Today we use computers and I have not used the debit and credit concepts in this book (they are confusing for non-financial managers). However, since accountants still rely on this double entry system when they discuss the company’s books and financial statements, it is good for you to have a basic understanding of what they mean.

Also added at the end of the Index are suggestions for further reading. The internet revolution has made relevant accounting and finance information easily accessible at all levels. In this section we have listed the best sources for more details for topics introduced in this basic text. On-line exploring can be fun and informative.

Enjoy the read. If you have questions or comments, please contact me. I’ll be happy to hear from you. My contact information is in About the Author.

Thomas Ittelson
Cambridge, Massachusetts

Preface to the 2nd Edition:
If the first edition of this book was an entrepreneurial business, it would be a huge success. Now over 100,000 copies of Financial Statements: A Step-by-Step Guide to Understanding and Creating
Financial Reports are in press and helping non-financial managers and students of accounting and finance cope with the “numbers of business.”
With this new revised second edition, we have expanded the book into five sections from the original three. Many readers of the first edition wanted to better understand making capital investment decision, the focus of our two new sections.
Capital is often a company’s scarcest resource and using capital wisely is essential for success. The chief determinant of what a company will become in the future is the capital investments it makes today. So in this new edition, we will use the financial analysis techniques of net present value (NPV) and internal rate of return (IRR) to make investment decisions.

Preface to the 1st Edition:
We needed to hire an accountant to keep the books at our venture-capital backed, high-technology startup of which I was a founder and CEO. I interviewed a young woman — just out of school — for the job and asked her why she wanted to become an accountant.
Her answer was a surprise to all of us,
“Because accounting is so symmetrical, so logical, so beautiful and it always comes out right,” she said.
We hired her on the spot, thinking it would be fun to have “almost-a-poet” keeping our books. She worked out fine.
I hope you take away from this book a part of what my young accountant saw.
Knowing a little accounting and financial reporting can be very satisfying. Yes, it does all come out right at the end and there is real beauty and poetry in its structure.

But, let’s discuss perhaps the real reason you’ve bought and are now reading this book. My bet is that it has to do with power. You want the power you see associated with knowing how numbers flow in business
Be it poetry or power, this accounting and financial reporting stuff is not rocket science. You’ve learned all the math required to master accounting by the end of the fourth grade — mostly addition and subtraction with a bit of multiplication and division thrown in to keep it lively. The specialized vocabulary, on the other hand, can be confusing. You will need to learn the accounting definitions of revenue, income, cost, and expense.

You’ll also need to understand the structure and appreciate the purpose of the three major numeric statements that describe a company’s financial condition.
Here’s a hint: Watch where the money flows; watch where goods and services go. Documenting these movements of cash and product is all that financial statements do. It is no more complicated than that. Everything else is details.
But why is it all so boring, you ask?
Well, it’s only boring if you do not understand it. Yes, the day-to-day repetitive accounting tasks are boring. However, how to finance and extract cash from the actions of the enterprise is not boring at all. It is the essence of business and the generation of wealth. Not boring at all.