Accounting Basics for IT Companies(PI)

1. Income Statement

An income statement, also known as a profit and loss statement (P&L), provides a summary of a company’s revenues, costs, and expenses over a specific period. It shows whether a company is making a profit or incurring losses during that time frame. The basic formula for an income statement is:

Net Income=Revenue−Expenses

Let’s consider an IT company developing software, Tech Innovators,  for the fiscal year ending December 31, 2022.



Pls check a video on Profit and Loss Account



2. Balance Sheet

A balance sheet provides a snapshot of a company’s financial position at a specific point in time. It consists of assets, liabilities, and equity. The balance sheet equation is:



Please see the video below for more details on Statement of Financial Position(Balance Sheet)


Financial ratios are key metrics derived from financial statements that provide insights into a company’s performance, efficiency, and financial health. Let’s derive and interpret some ratios based on the Profit and Loss Statement and Balance Sheet for Tech Innovators.

Gross Profit Margin:

Gross Profit Margin=( Gross Profit /Revenue)×100

This ratio measures the percentage of revenue that exceeds the cost of goods sold, indicating the profitability of the core business activities. A higher gross profit margin suggests efficient production and pricing strategies. For Tech Innovators

Gross Profit Margin=( $3,500,000 /$5,000,000)×100=70%

A 70% gross profit margin indicates that Tech Innovators is generating a strong profit from its software development activities.

Net Profit Margin:

Net Profit Margin=(Net Income/Revenue)×100

This ratio represents the percentage of profit a company earns for every dollar of revenue, providing insights into overall profitability. For Tech Innovators:

Net Profit Margin=($850,000 / $5,000,000)×100=17%

A 17% net profit margin indicates that Tech Innovators is earning 17 cents in profit for every dollar of revenue.

Return on Assets (ROA):

ROA=(Net Income/Total Assets)×100

ROA measures how efficiently a company utilizes its assets to generate profit. For Tech Innovators:

ROA=($850,000 / $4,100,000 /)×100≈20.73%

A 20.73% ROA indicates that Tech Innovators is generating about 20.73 cents of profit for every dollar of assets.

Debt-to-Equity Ratio:

Debt-to-Equity Ratio=(Total Liabilities/Total Equity)

This ratio measures the proportion of a company’s financing that comes from debt compared to equity.

Debt-to-Equity Ratio=( $2,000,000/$2,100,000 )≈0.952

A debt-to-equity ratio of 0.952 indicates that Tech Innovators has slightly more equity financing than debt financing.

Current Ratio:

Current Ratio=(Current Assets/Current Liabilities)

The current ratio assesses a company’s ability to cover its short-term liabilities with its short-term assets.

Current Ratio=($2,100,000 / $800,000)≈2.625

A current ratio of 2.625 indicates that Tech Innovators has sufficient short-term assets to cover its short-term liabilities.

These financial ratios provide a snapshot of Tech Innovators’ performance and financial structure. Interpretation involves comparing these values to industry benchmarks and historical performance to identify strengths and areas for improvement.

Video how to Analyse ratios

4. Cash Flow

Cash flow is a financial statement that provides an overview of how changes in a company’s balance sheet and income statements affect cash and cash equivalents. It categorizes the company’s cash inflows and outflows into operating, investing, and financing activities. It’s a crucial tool for assessing a company’s liquidity, solvency, and overall financial health.

Components of Cash Flow:

  • Operating Activities: Cash generated or used in the core business operations.
  • Investing Activities: Cash used for purchasing or selling long-term assets, such as equipment or investments.
  • Financing Activities: Cash from or used in activities related to the company’s owners and creditors, including issuing or repurchasing stock and paying dividends.


Cash Flow Statement for Tech Innovators (6-Month Period):

Cash from Operating Activities



Total: $1,800,000

Cash from Investing Activities

Q1:−$500,000 (investment in equipment)

Q2:−$300,000 (additional investment)

Total: -$800,000

Cash from Financing Activities

Q1:−$200,000 (share repurchase)

Q2:$0 (no additional financing activities)

Net Increase/Decrease in Cash



This simplified example indicates that Tech Innovators had a net increase in cash of $300,000 in the first quarter, and no change in the second quarter. Analyzing trends and fluctuations in these numbers helps the company make informed decisions about budgeting, investment, and managing cash flow effectively.

Video how to Analyse ratios


Published by Active Learning, Dec 2023