Financial Statement Analysis - Essay Example

Financial ment Financial ments A financial ment is a collection of formal records of the financial activities of the organization. They are written reports that quantify the performance, strength, and liquidity of an entity. It is simply a summary report that indicates how an entity has used it funds, entrusted to them by its lenders and shareholder (Collis, Holt, & Hussey, 2012). It also gives the current financial statement of an entity. They can also be referred to as accounting reports. Accounting assumption provides a foundation of the structure of financial practices and theories and explains why the financial records are presented the way they are. When auditors are auditing the financial statement of the firm, they check whether these assumptions have been violated, in case of violation the auditors will refuse to render a favorable opinion on the records. Therefore, that will call for new financial statements to be produced. There are four primary financial statements, which include: Statement of financial position: also known as balance sheet, it presents the financial position of a firm at a given date. It comprises of: Assets: something owned by the business (machinery inventory, cash) Liabilities: what business owes to someone else (bank loans). Equity: it is the difference between the assets and liability; it is what the business owes to it owner. Income statement: also known as a profit and loss statement. It reports the financial performance of an entity in terms of profit and loss over a specified period. It is composed of Income: it is what the firm has earned over a period (dividend income, sale revenue). Expense: the cost incurred by the firm over a period (wages and salaries, rental charges). Cash flow statement: it records the movement in cash and bank balances over a particular period. Cash flow is classified as follows: Operating Activities: cash flow from the prime activities of a business Investing Activities: represents cash flow from the purchases and sale of assets other than inventories (purchase of factory machinery) Financing Activities: it represents cash flow spent or generated on raising and repaying share capital and debt as well as the payment of interest and dividend. Statement of changes in Equity: commonly referred to as the statement of retained Earnings, it records the movements in owners’ equity over as period. It is derived from the following: report from the income statement, share capital repaid or issued during the period, dividend payments, effects of a correction of accounting error or change in the accounting policy, and gains, or losses documented directly in equity. Users of financial statement There are different kinds of financial statement users. First and for most the financial statements are meant to be understood by anybody who has background knowledge in business, accounting and economic field and who is willing to study the information comprehensively (Sandu, 2011). The users of financial statement use them for a variety of business purposes. Their ability to analyze and understand financial statement helps them to make wise decisions hence succeed in the world of business. As far as there are different kinds of financial states so as is it to the users, they could be inside or outside the business, hence classified as internal and external. Internal users Internal users consist of individuals who have a direct bearing with the organization. They include; Managers and owners: it is essential for the managers and owner of the business to know the financial status of their business to make intelligent business decisions based on facts. Financial statement helps the managers and the owner to be able to have a comprehensive view of the financial status of the company. Financial statement provides investment solution to an entity; they provide a proper guideline in which finance can be channeled. Employees: they are interested in the stability and profitability of the company; therefore, a financial statement is vital to employees. They can make a collective bargain based on the financial report. The financial reports help employees to know the possibility of their career opportunities and expansion. Additionally, they can discuss matters of pay rise, promotions, and ranking. External users Institutional investors: external users in most cases are the investors; they use the financial statement to know the financial strength of a business entity. This will assist them to make informed investment decisions. Additionally the financial reports help prospective investors to assess the potential profitability and success of a business. Financial institutions: financial institution includes banks and other lending institutions, therefore, financial statement helps the financial institutions to make decisions on whether to assist the business with working capital or offer them debt security. With the financial report, they will know whether the business will be able to pay the liability at upon maturity. Government: the financial statements of a company helps the government to know whether the company is paying the accurate tax and for regulatory purposes. Furthermore, with the financial statement the business the government can prepare their economic plan, since it is always influenced by the performance of the business within different sectors. Therefore, the financial statement forms the bases of their economic model, which is used to asses future performance. Vendor: they extend credit to business entities. Therefore, a financial statement is necessary so that they can be able to know the creditworthiness of the business. Whether the company can pay obligations when necessary or stipulated. Public: this group also makes it in the list of financial users. This is because there could be people out there as researchers, analysts, and students who could have an interest in the financial statement of a certain firm for valid reasons. The reasons can be a school research project or for business news especially in the media. Additionally, the public are considered the shareholders since a business cannot exist without the public. Moreover, business forms part of the larger society and that is why it attracts much public interest Usefulness of financial statements Financial statements provide vital information about the health of a company. Therefore, they are of concern to investors and creditors as well as to the owner of the business. The financial statements are compiled based on the daily bookkeeping in a business that tracks cash flowing in and out of the business in a regular basis. The records provide feedback and benchmarks that help the business to make adjustments. It also gives a business a clear direction. If a business has complete and accurate financial records then, there are high probabilities that sensible decisions will be made which will defiantly be realized later. Therefore, we can say that financial statements give information about the past performance the status and future prospect of the business. Furthermore, financial statements are helpful when making decisions regarding financial and expansion. They also help the business to figure into marketing decisions, because with the data provided they can know which type of operation offers the best returns (Chea, 2011). The profit and loss statement indicates the loss and profit that a business has made within the stipulated period. The statement gives information on whether the business is making profit, and it has lost or earned. The upper part of the statement lists the income while the lower part lists the expenditures. Therefore, it makes a clear presentation of expenses and income hence easy to analyze the profits of the company. The balance sheet shows the financial status or health of an entity. It lists the assets and liability of the company, therefore by the end of the day the company can know its net worth or value one the liabilities are subtracted from the asset. Cash flow statement marks the anticipated income and expenditure of a business at a particular period. It is a critical tool because it helps the management/owner to plan and anticipate revenue shortfalls by looking for financing or conserving the available resources (Megan, Schmidt and Cotlet, 2010). It has a section that indicates the expenditure (rent or payroll) and other section listing the anticipated revenue (sales from wholesale). Comparing the two sections one can tell whether the business will experience sufficient operational capital. The financial statement of an entity functions in a cyclic way. It provides the overall health of the business, it the profit and loss statement indicates that the company is making profit while the cash flow and balance sheet statement show that you are operating in the red. In most cases, the business is on the right tract it is just a matter of time before it catch up. It the profit and loss statement shows that the firm is making a loss while the cash flow and balance sheet projection indicate that the business has sufficient capital (Cole, Branson and Breesch, 2012). It is necessary to strategize on ways of making profit before the business runs out money and conserve on the available resources. In addition to that just like said above the financial statement also gives a clear picture to potential investors on the life span of the company. Therefore, they can know whether it is worth investing there. Financial statement also provides information to the financial institution, and they help them to make decisions on whether to extend finances to the company. Financial statements have many benefits and can be used for various functions. These include as an analytical tool, an early warning signal, a management report card, a measure of accountability and as a basis for prediction Both (internal and external) users of financial statement greatly benefit from the financial report. Therefore, it is a vital tool in any business. The users of the financial statement can make an informed decision involving an individual business whether a financial institution, owner or management or investor. The availability of a financial statement facilitates planning and projection (Abrams and Vallone, 2009). Every business should be extra caution not to make mistakes when making any financial transactions. As accounting deals with the financial transaction, therefore, every accounting work should be based on reasoning. Because creditors and investors in making credit and investment decision, it is imperative for financial reports to be dependable and truthful. Accountants are supposed to behave in an ethics way to ensure that the reporting process has adopted a code of ethics to which they must adhere too A business without proper accounting, as small as it can be it is not healthy. Since it does not have a basis, onto which it is conducting its business. Moreover, a business that does not ensure that the financial statements are comprehensive and accurate is like a business operation without the financial report; therefore, the success rate is close to zero. It is important to ensure that the financial statement is complete and accurate; this can be made possible by ensuring that daily bookkeeping on cash flow is maintained. It is important to note that as much as I have used the term “business”, it is not limited to moneymaking entities. Public sectors such as NHS, local authorizes and non-governmental organizations draft financial statements that guide them in the operation of the organization. Therefore, we can conclude by saying the financial statements are vital to all groups. References Abrams, R. and Vallone, J. (2009). Business plan in a day. Palo Alto, CA.: Planning Shop. Azad, A. (2004). Assessing the quality of earnings: a survey of financial statement users’ perceptions towards the reporting importance of selected categories of information. Journal of International Business Research, 3(2), pp.1--20. Bernstein, L. (1993). Financial statement analysis. Homewood, IL: Irwin. Brentani, C. (2004). Portfolio management in practice. Oxford [England]: Burlington, MA. Chea, A. (2011). 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