Financial Performance of a Business - Assignment Example

?Evaluate the Financial Performance of a Business Discuss the main financial ments; Business organizations are mainly concerned with financial activities. In order to understand the financial strength and financial status of the business, every enterprise should prepare certain statements known as financial statements. Financial statements give complete information about equity, assets, liabilities, expenses, reserves and profit and loss of a concern. These statements help the management in making right decisions. The following constitute the basic financial statements. Balance sheet Income statement and Cash flow statement. These are the basic statements normally prepared by profit-oriented corporations. These statements help in knowing the profitability and financial soundness of the business concern. These are prepared at the end of a given period of time. Financial statements are used as an important tool to communicate the financial information to parties outside the organization (such as investors, creditors, and other external decisions makers). The Balance Sheet; The purpose of preparing balance sheet is to report the financial position (amount of assets, liabilities, and shareholders’ equity) of a firm during a particular period of time. A balance sheet contains complete information about assets, liabilities, and shareholders’ equity of the company. Assets; Assets are things which have economic value and that which are owned by the company. It include tangible asset, such as plants, trucks, equipment, and inventory. It also includes intangible asset, such as trademarks and patents. Cash itself is an asset. Tangible asset can be divided into two, Current asset and fixed asset. Current asset represent the company’s liquidity. This is where companies list all of the stuff which can be converted into cash in a short period of time, usually a year or less (Kennon 2012). Fixed asset is an asset held with the intention of being used for the purpose of producing or providing goods or services, and it is not meant for sale in the normal course of business (Accounting for Fixed Assets n.d). Liabilities: Liabilities include all kind of obligation that a company have. The term liabilities mean the amount of money that a company owes to others. Shareholders’ equity; It is also called capital or net worth. The following formula summarizes what a balance sheet shows: ASSETS = LIABILITIES + SHAREHOLDERS'EQUITY Income Statements; Income statement is a statement which shows the revenue that earned by the company during a specific period of time (usually for a year or some portion of a year Income statement also shows the expenses, and the cost associated with the earning of revenue. Income statement also gives information regarding how much the company earned or lost over a period of time. This statement helps to calculate earnings per share (EPS), and it also tells how much money shareholders would get, if the company decides to distribute the whole earnings of the company. Income statement can be also called the statement of operation, or statement of earnings. Statements of Cash Flow; A cash flow statement is a statement that contains a detailed report regarding the company’s inflows and outflows of cash. Cash flow statement is helpful in knowing the net increase or decrease in cash for the period. It is prepared by using the information and reports in the company’s balance sheet and income statement. Cash flow statement is helpful in recognizing the, changes in cash balance(increase or decrease) sources of cash uses of cash There are three parts included in the cash flow statement. They are (1) operating activities; (2) investing activities; and (3) financing activities. 2. Compare appropriate formats of financial statements for different types of business The financial statements explain from where a company's funds come from, where it goes and where it is at present. “Owners and CEOs use these statements to manage a business, bankers to check its creditworthiness, and investors to gauge its potential for dividends and growth” (Randolph 1999). Financial statements are designed in different ways: The financial position statement or balance sheet, the statement of income or income sheet, and the cash flow statement are cases in point. A balance sheet statement includes assets and liabilities, an income sheet comprises of income, profits and expenses, and cash flow statement reports on investment, operations and the financial cash flow activities. Balance sheets are normally classified into two sections as assets and liabilities and net worth, to explain the financial income of company and balanced output against each other. Balance sheets frequently differ in complexity depending on the size of the business they feature. Income sheet explain the change of revenue into net income and has simple intention of showing investors and company managers whether the business has made or money lost during a exact financial period. The cash flow statement shows the incoming and outgoing of cash during the business’ reporting period.  Financial Statement Format of Sole Proprietorship: It includes a trading and profit and loss account, showing profit or loss of business and balance sheet showing asset and liability of business. Financial Statement Format of Partnership: In partnership firm while preparing the financial statements, the income statement would generally be prepared initially as net income or loss forms part of the statement of partners’ capital. The statement of partners’ capital is typically prepared secondly, as ending partners’ capital balances form a part of the balance sheet. The Financial Statement of Public Company Annual financial statements consist of an income statement, balance sheet with supporting notes, cash flow statement, auditor’s report, and directors' report. These yearly financial statements have to be submitted to the shareholders and to the government at least once in a year. The director’s report describes and includes detail to the figures and the matters related to enhanced understanding of the position of the company. The auditor's report is the report presented to the members of the company. It proves that financial statements are verified, and that the auditor is satisfied about the company’s financial position and its financial results. The only distinction is in the balance sheet format and in the supporting notes for sole proprietors, partnerships, and public companies in owner's equity part. The income statement’s format for sole traders, partnership firms, and public companies, is precisely the same. The mere difference in this statement is that, as the public company is an artificial lawful entity, it should pay income tax. Differences between the income statements of sole proprietors, partnership firms and public company Sole traders and partnerships Public companies Sales (net) Turnover Less: Cost of Sales Less: Cost of Sales Gross Profit Gross Profit Add: Other Income Add: Other income Gross Income Gross income Less: Operating expenses Less: Operating expenses Operating profit Operating profit Interest Income Interest income Profit before interest expense Profit before interest expense Interest expense Interest expense Net profit (loss) for the year Net profit (loss) for the year Taxation/Income tax Net profit after tax for the year (Accounting the Financial Statements n.d). 3 Interpret financial statements using appropriate ratios and comparisons, both internal and external: The analysis of financial statements is the procedure of examining relations between various aspects of the organization’s financial statements, and making comparisons with appropriate information. It is a valuable tool used by creditors, investors, financial analysts, managers, owners and others in their managerial process. The analysis of financial ratios is the general structure of financial statements analysis. “Financial ratios involve the comparison of various figures from the financial statements in order to gain information about a company's performance” (Financial Ratios (Encyclopedia of Management) 2012). Financial ratios demonstrate the relations of various parts of firm operations, and they give relative actions of the organizations performance and conditions. Financial ratios can give symptoms and clues of financial indications, and also that of probable problem areas. Financial ratios normally hold no meaning, unless they are evaluated against something as well, like the performance of earlier period another competitor or company, or industry average. Therefore, the ratios of organizations in different industries, which face various circumstances, are generally hard to compare. Financial ratios can be a significant tool for small business managers and owners, to measure their development, in addition to competing with better companies in the industry. Tracking different ratios over time is a powerful method of recognizing trends. Ratio analysis, when performed frequently over time, can also help small businesses identify and adapt to trends influencing their operations. Financial ratios are also utilized by investors, bankers, and business analysts to evaluate different attributes of operating results or the financial strength of organizations. This is another reason for business owners recognizing financial ratios. Quite frequently, the capacity of a business in obtaining finance or equity financing depends on the organization’s financial ratios. “Users of financial ratios include parties both internal and external to the firm” (Financial Ratios (Encyclopedia of Management) 2012). External users contain security analysts, potential creditors, current creditors, investors, competitors, and other business observers. Internally, managers utilize ratio analysis to observe and identify strengths and weaknesses: and also performances from which particular objectives, goals and policy initiatives can be formed. Financial ratios are classified according to the financial part of the business in which the ratio includes. Ratios can serve as clues or indicators, concerning noteworthy dealings between variables used to calculate the firm's performance in terms of asset utilization, profitability, leverage, liquidity, or market valuation. Liquidity ratios study the accessibility of the organization’s cash to pay debt. Profitability ratios calculate the organization’s use of its assets, and the management of its expenses to create a suitable rate of return. Leverage ratios observe the organization’s process of financing, and calculate its facility to meet financial requirements. Efficiency ratios calculate how quickly an organization converts non-cash assets to cash assets. Market ratios calculate investor reply to owning an organization’s stock, as well the cost of issuing stock. Reference List Accounting the Financial Statements n.d). K 12 SCHOOLS Your Education Portal. [Online] Available at [Accessed on 25 May 2012] Accounting for Fixed Assets (n.d). [Online] Available at [Accessed on 25 May 2012] Financial Ratios (Encyclopedia of Management) (2012). [Online] Available at [Accessed on 25 May 2012] Kennon, Joshua (2012). Current Assets on the Balance Sheet. Investing For Beginners. [Online] Available at [Accessed on 25 May 2012] Randolph, Henry (1999). Types of Different Business Finanacial Statements. eHow money. [Online] Available at [Accessed on 25 May 2012] Read More