Analysis of Financial Statements
In any business undertaking, an exchange takes place; therefore, cash flows involving money characterize such activities. Transactions that are done would require an exchange of money or services, which are viewed in monetary terms. The recording of undertakings concerning money is known as accounting, while records or registers showing how money have moved within business enterprise or persons are called financial statements. Simply put, such are registers of financial activities regarding some entity. They are to be easy and presented in a manner that is easy to understand.
The purpose of keeping the financial statements is to use them for future reference. Due to various reasons, such records could be useful to different entities in the future. They supply information about the financial position, the performance and changes in financial status of the enterprise, which are considered useful to a wide range of users, as they seek to make decisions (Ray, 2000). Financial statements aid in deliberating on making informed decisions. Statements have the following relevance to various groups of persons.
Records are helpful to owners and management. They need financial statements information to make crucial business choices or changes, which affect business operations. Through financial analysis, management or owners are supplied with detailed information or data contained therein. Financial statements too are used as part of management reporting to stakeholders periodically, as provided by various legal systems.
Employees would also be interested in the information contained in financial statements. The information could guide them on the progress being made by the enterprise. Therefore, they would be able to negotiate effectively with management on salaries and remuneration. They could also require information for general knowledge, since they need to be informed on affairs regarding their employer. From the information in financial statements, employees are able to rate their performance and gauge, if they have delivered on their goals or are still some miles away from attaining goals.
Prospective investing encompasses the willingness and ability of persons who want to invest in an enterprise. Before they commit their resources towards the enterprise in question, they may want the information regarding the capital base of the enterprise and its profitability. This information is available from financial statements. Therefore, the provision of relevant data for investor analysis and the subsequent drawing of decisions concerning investment are possible by reviewing financial records.
Lenders cannot be left out of brackets of interested parties regarding financial statements. These persons provide funds for investment purposes. They, however, base their lending on various factors like credit worthiness, capital base and available resources. Reputation of an enterprise is also crucial. Those enterprises that are able to earn immense profits enjoy a decent reputation. Hence, they would easily be granted credit to pursue various activities. Therefore, these parties would be keen to study the financial standing of various organizations, so that they are informed on persons that they transact business. This information is provided in financial statements. They are, therefore, informative to lenders.
Authorities or governments too, have been interested in happenings in various organizations within their areas of the scope. Some sources of information are through studying of financial statements. These institutions may want such information for taxation purposes. By knowing amounts of profits earned by some enterprises, authorities would gauge levels of taxation for funding of public activities and duties like provision of healthcare, security etc. As a regulator, the government is also keen on purposes of the national security and protection on some interests. These documents, therefore, offer authorities some sources of vital information.
There also exist other groups with interest in proceedings of some business enterprises. The media, analysts and students may want the information for reporting purposes and learning. Therefore, the point here is to get the information and inform or enlighten the rest on knowledge purposes. These persons may want to know the performance of various business entities. This would help in informing the rest who may be in the dark regarding such issues.
On financial statements, they have been defined as registers of financial activities within some enterprise or involving some persons. There are mainly four of them. The statement of financial positions, also known as the balance sheet, is one of them (Elliot, 2004). This statement shows assets owned by an enterprise, liabilities accruing to the enterprise and the level of the owners’ equity. It provides information about an enterprise’s resources and claims to resources.
The other document is the statement of changes in equity that depicts changes to an enterprise regarding equity (Elliot, 2004). This is done during the whole period of the reporting. It serves to reconcile the owners’ equity section of successive balance sheets, showing how generated income has since changed. Another one is the statement of comprehensive income, which is also referred to as the profit and loss account. This, reports on an enterprise’s expenses and profits. This is done over some period in time, say annually. It provides information on profitability of a business showing sources of revenue and expenses. It thereby shows sources and uses of a firm’s financial resources and trends in alteration of the capital structure.
Reasons for Using Financial Ratios
Financial ratios pass information on the liquidity, activity, profitability and leverage regarding undertakings of an organization. Often ratios are used to gauge performance or point at problematic areas (William, 2000). They are crucial to indicate various symptoms. For instance, ratio analysis may reveal an upsurge in the volume of sales as compared to inventory and receivables. However, inventories may increase less rapidly than such sales, according to inability to replace such inventory items, reduced costs of goods, change of inventory policy or in inventory valuation. Receivables could have expanded less rapidly than sales as a result of a more conductive collection policy or some adjustments in policy as it regards to advancement of credit. Therefore, ratio changes and analysis make managers ask some valuable questions thus helping in decision-making.
Examples of Ratios
Financial ratios have been classified, based on the information that they rely on. There are liquidity ratios, which show the ability of an enterprise to have funds to pay debts to creditors. Activity ratios measure how fast or urgent an enterprise can convert non-cash assets into cash. The other kinds of ratios are debt ratios, which measure how quickly an enterprise can settle a long-term debt. The profitability ratios show what the business’s use of assets is. It also shows how a business controls its expenses to pave the way for an acceptable rate of return. The last ratios are market ratios, which measure the response of investors towards owning a company’s stock and the cost of issuing stock. Normally, the focus is on the return on investment.
Importance of the Generally Accepted Principles of Accounting
This involves a set of principles that guide the practice of accounting. They are formulated with an aim of making the practice of accounting professional and embrace ethics in a bid to ensure that carrying out of duties related to accounting is appropriate. The aim is to ensure that information generated is reliable for the usage. Some principles include the principle of consistency, the principle of regularity, the principle of sincerity etc. For example, the principle of consistency ensures that the method that is used is in conformity with previous ones, so that it becomes easy for analysis and comparisons. The principle of sincerity ensures that the information used and recorded in the financial statements is correct and does not, therefore, cause any misleading information. Thus, they seek to streamline the practice of accounting.
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