Balance Sheet, Cash Flow Statement and Income Statement - Essay Example

Financial Statements Report Name Student ID Course Instructor Date Financial Statements Report Executive Summary Financial statements include balance sheets, income statement, and cash flow statement. Balance sheets refer to reports of monetary position of an organization at a specified point in time. Income statements report the outcome of earning activities for a specified period of time. Cash flow statements report cash inflow and outflow from operations within a reporting duration. All business transactions lead to alterations in assets, liabilities, and owner’s equity. All transactions has double effects in accounting equations and the double entry process is referred to as double entry accounting leading to utilization of credit and debit entries. Ethics in accounting relates with making appropriate and moral choices regarding the preparation, arrangement, and release of monetary information. The main ethical issue in previous years relate to fraudulent reporting and misappropriation of assets. If financial statements are unethical, they are useless and are not reliable. The major weakness of use of financial reports is that the information is based on the business at a specified point in time; changes in the market may results to changes in the financial statements within a short period. The main strength of the use of financial statement is that they are used for future planning and making of vital decisions. Also, government agencies utilize financial statements in the determination of the appropriate taxation Introduction Financial statements refer to formal records of the monetary activities of an organization, individual or other entities. Applicable financial information is made in a controlled manner and in a way that is easily understandable (Linsmeier, 2011, P. 412). Financial statements include balance sheets, income statement, and cash flow statement. Balance sheets refer to reports of monetary position of an organization at a specified point in time. Income statements report the outcome of earning activities for a specified period of time. Cash flow statements report cash inflow and outflow from operations within a reporting duration. Balance sheets indicate what is a business owns and what it owes. Financial statements evaluate a business’s financial performance, examine relations by use of trends evaluation and horizontal analysis, compare an organization to its industry and analyze rations concerning numerical calculations. It’s a requirement by law that limited companies produce financial statements. The statements ought to be published and made publicly available to all stakeholders. This paper is a report to the newly appointed CEO who has limited knowledge of accounting. Therefore, it seeks to assess financial statements, their weakness and strengths, how they are prepared, ethics of preparation, and how they are analyzed. Balance Sheet, Cash Flow Statement and Income Statement Balance sheet refers to a summary of the monetary balance of a business. It describes the fiscal condition of a business at a specified time. It has three sections which include liabilities, assets, and ownership equity. Assets are listed in order of liquidity and the liabilities follow. The difference between assets and the liabilities is referred to as equity or the capital of the business Minnis, 2011, P. 460). Cash flow statement refers to a financial report that portrays how alteration in a balance sheet is accounted for and the effects of income on cash equivalents. It concentrates on the cash that flows in and out of the company (Linsmeier, 2011, P. 410). It focuses on both the instant operating effects and the resultant change in the balance sheet. It determines short-term viability of a business, specifically the ability to clear debts. Various people interested in cash flow statements involve potential employees and contractors who require information of the company’s ability to offer compensation, creditors of the company, accounting staff, potential creditors, and potential investors. Income statement is also referred to as profit and loss statement, statement of financial performance, and operating statement. It is used in prediction of amounts, duration, and precision of future cash flows. It assists users in determining the danger of failing to attaining specified cash flows, evaluation of predictable performance, and evaluation of possibility of repayment to creditors (Costello, 2011, p. 100). The limitations of income statements are that the information is based on the past and they include only quantifiable date. All business transactions lead to alterations in assets, liabilities, and owner’s equity. All transactions have double effects in accounting equations and the dual entry process is referred to as double entry accounting, resulting to utilization of credit and debit entries (Chen, Hope, Li, & Wang, 2011, P. 1256). After the recording of every transaction, the accounting equation remains balanced. In a business, cash inflows include funds generated from normal activities, sales of business assets and liquidation of long-standing reserves, and sale of bonds, stock, and other securities. Cash outflow include funds spent on normal operations, purchase of business equipment, and payment of cash bonuses, stock, and repurchase (Persons, 2011, p. 40).An item that is definable as an element of account should have the potential to benefit a company economically either inward or outward and has value which is measurable with reliability. Financial statements analysis is vital step in any company as it presents significance information concerning the economic status and profit margin of the business. The statements assist an investor, business regulators, and the administrators understand operating information, assess cash receipt and imbursements, in a certain period and review personal investment of the business. Ethics in financial accounting Ethics in accounting relates with making appropriate and moral choices regarding the preparation, arrangement, and release of monetary information. Matters presented in accounting ethics helps a business identify the consequences for the actions it takes. Majority of accounting scandals in previous years relate to fraudulent reporting. It refers to the releasing inaccurate statements by business administrators. In many cases, this happens so as to mislead investors and maintain the organization’s share price (Choi and Pae, 2011, p. 410). The consequences of a misstatement may benefit the organization’s short term stock price; there are numerous negative consequences of this act in the long run. Focusing on a business’s short term benefits while ignoring the long term effects is referred to as myopic management. On personal employee level, the most frequent ethical issue is the misuse of assets. It refers to use of an organization’s assets in other purposes other than those that target the interests of the organization. It is also referred to as misappropriation and may occur at different levels of a company (Costello, 2011, p. 100). An example of misappropriation of assets is when a business executive changes a family dinner into a business expense. Also, an employee may take various business supplies at home for family use. In these instances, embezzlement has taken place. Disclosure is an additional issue in fraudulent financial statements. It refers to errors of ethical omission. Whereas intentional recording of inaccurate transactions results to fraudulent statement; also, failing to disclose certain information to investors that would affect their decision about investing in the organization is fraudulent reporting. The administrators of an organization ought to protect its trademarked information; nevertheless, if the information recounts to vital events, it is unethical to withhold such information (Choi and Pae, 2011, p. 411). Ethical financial statements have specified qualities that include compliance with accounting standards, transparency, and demonstration of economic value of an entity. Ethical rules are very significant as they offer codes that guide behavior; ethical behavior is not governable by rules alone. If financial statements are unethical, they are useless and are not reliable. Companies that uphold strong ethical identity seem to maintain high levels of customer satisfaction influencing the financial outcome the business. The foundation of effective functioning during financial statement preparation is the capability of the auditors to practice professional judgment by applying the principles and ethics that relate to the accounting issue at hand. The foundation of such judgment ought to have appropriate documentation, which will assist regulators reflect on and dispute judgments that do not meet the criteria. The sensibleness of the judgment is assed basing on the facts and knowledge present at the time it was made. Strengths and Weaknesses Financial statements have various limitations. Various companies utilize different accounting methodologies making comparison difficult. The main weakness of utilization of financial reports is that the information is based on the business as specified time. Changes in the market may results to changes in the financial statements within a short period of time. Hence, investors should not assume that past financials reports ought to remain constant or increase in the future (Chen, Hope, Li and Wang, 2011, P. 1258). Just because a company sold numerous copies of a given product in a year, it is not guaranteed that it will sell such copies in the future. It may sell fewer if competitors release similar products. The fist strength of financial statements is that they demonstrate a company’s yearly earnings. The sales are not constant and it is and financial executives should be able to establish a pattern over years of sales information. The sales may reduce after a given period of time which is significant as it as the executives are aware of what to expect. Another weakness of single financial reports is that it only portrays the progression of a company in a specified point in time and does not show any improvements or worsening that the previous year. Hence, continuous analysis is very significant for a business compared to one time statement. An additional advantage of the use of financial statement is that they are used for future planning and making of vital decisions (Peecher, Solomon and Trotman, 2013, p. 600). The budgets show the amount of finance a company ought not to exceed while launching products, establishing market campaigns, or for business extension. The knowledge of the amount of finance available for planning makes sure that the business does not overspend more than the expected value. Governments and regulatory agencies utilize financial reports in determination of the legality of the decisions made by a business in every financial year. In addition, government agencies utilize financial statements in the determination of the appropriate taxation. Balance sheets offer the monetary worth of a company in a specified point in time. It is significant in the determination of the monetary reliability of a business (Agoglia, Doupnik and Tsakumis, 2011, p. 750). The current ratio portrays the relation of current assets available in meeting the obligations of the company. The quick ratio involves those assets that are effortlessly changeable into cash, establishing the immediate working capital relations. The debt to equity ratio shows the owners of the largest proportion of the company amongst the creditors and the shareholders. Efficiency ratios show the efficiency of a business in turning inventory into revenue. The day sales outstanding ratio concentrates on the duration needed to convert inventory into cash and the age of the accounts that can be received (Ball, Jayaraman and Shivakumar, 2012, p. 140). The inventory turnover ratio indicates the frequency by which a business is capable of moving its merchandise. Accounts payable to sales indicates the proportion of sales financed by suppliers’ cash. Profitability ratios show a company’s accomplishment at making profits. The profit margin of a business determines its capacity to endure competition and hostile environment. Report on assets shows profits gained for every dollar of assets and estimates a business’ efficiency in profit generation. Manipulation of figures hides the real state of a business. Another weakness is that various accounting methodologies appear distinct on paper and each methodology changes the identifiable health, profit margins, on both sides (Agoglia, Doupnik and Tsakumis, 2011, p. 752). Quantitative financial analysis is a skill and distinct analysts may provide different results from similar information. Case Studies There are various methods of financial statement analysis which include horizontal and vertical analysis. Horizontal analysis refers to comparative analysis between various reporting periods. Vertical analysis refers to the proportional analysis of financial reports whereby, every line item on a financial report is given as a proportion of another item. Generally, each line of goods on an income report is indicated as proportion of the gross sales; whereas, each line item on is listed as a proportion of the total assets. The other method for assessing financial statements is the utilization of various ratios to estimate the relation size of one number with another. After the ratio is acquired, it is compared with the ratio of a previous reporting period of a business standard figure so as to identify if the company is meeting its expectations (Persons, 2011, p. 43). Wrong financial statements may present wrong advice to shareholders and potential investors. In a case study involving National Australia Bank, the company paid millions for compensating over 700 clients who were presented with wrong financial advice. The bank had several financial advisers but its administrators made a mistake by assuming all financial advisers are precise. Financial statements are used to determine the economic status of a company. For example, a study for analysis and interpretation of financial statements of ACC Ltd carried out between 2004- 2009 indicated that the current ratio of the company was always below 1, portraying that the liquidity position of the company’s liquidity status was bad. For the Jindal Steel & Power Ltd, the ratio was acceptable as it was always above 1 for the period of the case study (Das, 2010). The Debt to equity ratio of the Acc Ltd reduced form 0.5- 0.007 between 2004 and 2007, and then improved to 0.09 in the year 2009 indicating that debts were cleared. For the JSPL, the ratio ranged between 1.13 and 0.91. Increased investment led to an increase in the Debt- Equity ratio. Conclusion This paper has assessed financial statements, their weakness and strengths, how they are prepared, ethics of preparation, and how they are analyzed. To understand the worth of a business, investors evaluate its fiscal position. Also, government agencies, shareholders, and the management of a company are all interested in financial statements. Creditors wish to know if the company is able to pay its debts, investors aim at finding out the company can pay dividends, the management requires financial statements for future planning, and government agencies require these reports for determination of tax. Bibliography Agoglia, C. P., Doupnik, T. S. and Tsakumis, G. T. 2011, Principles-Based Versus Rules-Based Accounting Standards: The Influence Of Standard Precision And Audit Committee Strength On Financial Reporting Decisions. The Accounting Review, 86(3), pp. 747-767. Ball, R., Jayaraman, S. and Shivakumar, L. 2012, Audited Financial Reporting And Voluntary Disclosure As Complements: A Test Of The Confirmation Hypothesis. Journal of Accounting and Economics, 53(1), pp. 136-166. Chen, F., Hope, O. K., Li, Q. and Wang, X. 2011, Financial Reporting Quality And Investment Efficiency Of Private Firms In Emerging Markets. The Accounting Review, 86(4), pp. 1255-1288. Choi, T. H. and Pae, J. 2011, Business Ethics And Financial Reporting Quality: Evidence From Korea. Journal Of Business Ethics, 103(3), pp. 403-427. Costello, A. M. 2011, The Impact Of Financial Reporting Quality On Debt Contracting: Evidence From Internal Control Weakness Reports. Journal Of Accounting Research, 49(1), pp. 97-136. Das, S. 2010, Analysis and Interpretation of Financial Statements: Case Studies (Doctoral dissertation, National Institute Of Technology, Rourkela). Linsmeier, T. J. 2011, Financial Reporting And Financial Crises: The Case For Measuring Financial Instruments At Fair Value In The Financial Statements. Accounting Horizons, 25(2), pp. 409-417. Minnis, M. 2011, The Value Of Financial Statement Verification In Debt Financing: Evidence From Private US Firms. Journal of Accounting Research, 49(2), pp. 457-506. Peecher, M. E., Solomon, I. and Trotman, K. T. 2013, An Accountability Framework For Financial Statement Auditors And Related Research Questions. Accounting, Organizations and Society, 38(8), pp. pp. 596-620. Persons, O. S. 2011, Using Financial Statement Data To Identify Factors Associated With Fraudulent Financial Reporting. Journal Of Applied Business Research (JABR), 11(3), pp. 38-46. Read More