Financial Intelligence for Entrepreneurs - Term Paper Example

Lecturer: Presentation: Introduction Financial accounts are significant for an organization in keeping track of all its monetary transactions. This enables the managers to know the manner in which cash is moving in and out of the organization. These accounts reflect important features of a business such as revenue, overheads, proceeds, assets, liabilities and owner's equity amongst other essential aspects of the organization's finances (Berman 2008 p 8). The balance sheet and the profit and loss account are two of the important financial accounts. They are important for the management especially in decision making. All decisions regarding investments are based on the financial accounts. They indicate an organization's potential in regard to investment. This means that the financial status of the organization can be known by simply looking at these accounts. The users of these final accounts include the owners of business, managers, shareholders, government, creditors and the directors amongst other stakeholders of the business. These are mainly the people who are directly affected by the performance of the business, which is a significant factor in regard to credit worthiness of a business. On the other hand, government taxation is usually levied depending on the profitability and size of the organization. These aspects can be known through the final accounts (Dyson 2001 p 45-48). This essay is a critical evaluation of the purpose of the Profit and Loss Account and Balance Sheet to the various users or stake-holders. Balance Sheet This is a critical component of an organization's financial report that provides information regarding capital, the long and short term assets as well as long and short term liabilities. This means that the owners of the business can get information regarding the possessions as well as the debts of the business by simply looking at the balance sheet. It is significant in avoidance of losses in the business operations. It indicates whether assets match with the liabilities hence it is useful in setting up the business strategy. This is mainly because a business will try as much as possible to ensure that the liabilities are checked in order for them not to go beyond a certain level whereby the debts may be more than the assets, a situation that may lead to insolvency of the business, which according to Berman (2008 p 11) is referred to as balance sheet insolvency. The wise use of the balance sheet can help in avoiding bankruptcy. The balance sheet is also significant in the evaluation of expenditures as well as the debts incurred by the business. The total spending by the business in a trading period is reflected in detail on the liabilities section. This gives the managers an opportunity to understand the items which significantly reduce the assets of the business. This knowledge is important in helping the managers to develop strategies for reducing the expenditures especially on the needless items. Expenses can be reduced through the use of inexpensive materials as well as the expenses that the business can do without. Strategies can also be developed to leave the assets that are not very necessary to the organization in order to pay the owing debts. (Weekman 2003 p 45- 51). Most of the time a business will be anticipating income which needs to be tracked in order to ensure that it is not lost before it is acquired. The balance sheet helps in tracking these receivables. It gives a detailed list of these receivables which indicates the payments owed to the business by customers. These payments are usually apparent in the balance sheet, which makes it possible for the managers to make a follow up in regard to their clearance. It is also significant in helping the managers to make a critical analysis of the inclination of the receivables and the amounts owing (Dyson 2001 p 56). They are able to identify whether the anticipated income is taking longer than expected and whether there is anything that can be done to facilitate the collection of receivables. On the other hand, it is also easy to tell whether all the debts will be paid or there is a possibility of bad debts. The managers may also analyze the trends in the clearance of payables. This is usually important in ensuring that they are not cleared in an unnecessarily rapid manner which may pose the threat of an unavoidable shortage of cash inn the business. The balance sheet is also important in providing information concerning equity. This is important to the owners and stakeholders since it helps in understanding what they have invested within the year. They can then make the necessary changes in the business in order to ensure that the business produces more returns. This understanding is also a significant determinant of the quantity of investment that will be added in the next trading period (International Labour Office 1991 p 56). Shareholders are essential for the business especially in raising capital. They should therefore be presented with clear financial statements in order for them to know the assets that the business possesses. The balance sheet provides this information, which helps the stakeholders to have a clear view of the organization's financial requirements in regard to capital. They can easily tell the amount that is needed from them. In case the reflection on the balance sheet indicates that the business is performing poorly, the shareholders may decide to forfeit some of their shares. The balance sheet is therefore an important tool for the business owners and stakeholders in determining its performance. In order for managers to allocate resources effectively, it is important to ensure that they have a strong reference. The balance sheet plays a significant role in displaying the movement of assets in the operating environment as well as outside the business, which helps in ensuring that the managers are able to avoid issues concerning allocation of finances in the business. This helps in avoidance of inconsistency that may harm an organization's reputation. The balance sheet portrays the effectiveness of utilization of the investment capital of the stakeholders (Stickney and Weil 2002 p 56). The balance sheet is also essential in helping the owners especially of small businesses to analyze the strengths and weaknesses of the business. If they find that the business is financially strong, they are able to tell whether it is likely to expand (International Labour Office 1991 p 66). On the other hand, they can also be able to analyze the capability of the business in coping with the problems that might arise from failure of clearance of all the receivables as well as much expenditure in the organization. It is also important in determining whether the business requires more cash to be kept as reserve within the business. It reflects the manner in which the business has been funded as well as the effectiveness of the utilization of these funds. Businesses usually solicit funds from creditors in order to boost their capital. However, in order for lenders to approve a loan, the borrower must show potential in repaying the loan. The business owner can present several balance sheets which indicate the growth of the business net worth over a particular period of time. Under such a case, it can assist in supporting the application for credit. The balance sheet is a clear indicator of this potential. Presenting it to the creditors helps them to evaluate the creditworthiness of the business. If it indicates that the business is insolvent, it may be denied a loan, especially when the liabilities surpass the assets by a great difference. On the other hand, they are able to see the current and the long term liabilities and evaluate whether the business is able to repay the loan at a particular time when it will also be repaying its loans borrowed from other creditors. This is important for the lenders in determining how much loan to offer the business (Stickney and Weil 2002 p 75). Renewal of loans is important for a business that shows signs of growth. The owners have to convince the creditor that they need the renewal or renegotiation of a short term loan to a long term one. The balance sheet helps the business owner to make an analysis of his ability to clear the liabilities, especially those that are due within a short period. The owner can begin looking for ways to acquire funds to repay the loans. He is also capable of assessing whether the value of the current assets is equivalent to the short term liabilities, which means that they can be sold in order to take care of loans that are due (International Labour Office 1991 p 63). The Profit and Loss Account The aim of engaging in any business venture is usually to make profits. A business that does not make profits may not be worth undertaking. The profit and loss account is significant in assessing whether profits have been made in a particular period of time. It is a significant indicator of the performance of the business in terms of maintenance of revenue, as well as its ability to ensure that a low cost of production is maintained. The fixed costs are significant in the profitability of the business. This account helps the business to check these costs in order to ensure that the business makes profits. Traders use it to determine the growth of the business over several years through making a comparison to the profit and loss accounts of the previous years. On the other hand, managers can compare it with those of other businesses in order to establish its performance amongst competitors in the same field (Weekman 2003 pp 66-71). People willing to invest their money in shares usually focus on an organization's profitability. The profit and loss account helps them in analyzing the potential of different organizations. It is generally understood that it may be risky to buy shares in a business that is running at a loss. Information from the profit and loss account is therefore essential for the investors. The government on the other hand uses the profit and loss account to determine if the tax charged on a business is appropriate. Profitability of a business indicates its ability to pay taxes (Dyson 2001 p 67-72). In regard to the personnel, salaries are raised depending on the organization's ability to pay. Higher profits attract experienced personnel to the organization. The profit and loss account helps the managers to analyze the capability of the organization to employ more staff. This usually depends on the analysis of the overheads which are indicated in the profit and loss account. The appropriation of profits is important for the business and is achieved after a successful preparation of the profit and loss account. The business can expand through ploughing back the profits. Managers use the profit and loss account in planning ahead for sustainable profitability. The expenses that cause a decline in profits are usually apparent on the profit and loss account (Stickney and Weil 2002 p 115). The managers can use it as a basis of investigating the flaws in the business operations leading to a reduction in the organization's profits. The profit and loss account is also used by organizations that are willing to merge or acquire others. Both organizations have to assess the accounts of each in order to predict the outcome of a merger. In many situations, what the business reflects on the profit and loss account determines whether the merger will take place. The account is also useful for the head office in an organization that operates through foreign subsidiaries such as the multinational companies. Each subsidiary presents its profit and loss account, which is used by the main company to help it determine whether it is worth to invest in particular localities. If a foreign subsidiary operates at a loss, the main branch may decide to cease its operations (Stickney and Weil 2002 p 117). Conclusion Financial accounts are essential elements in an organization. They provide a basis for assessing the performance of a business by its owners as well as its stakeholders. The financers of the organization use these accounts to determine whether it is worth funding. The accounts also indicate its credit worthiness to the lenders. They are useful when the managers wish to make long term plans including mergers and acquisitions, as well as the assessment of the impact of certain decisions such as maintaining the operations of foreign subsidiaries. Bibliography 1. Berman K., Knight J. and Case J. 2008. Understanding Balance Sheet Basics: Financial Intelligence for Entrepreneurs, Harvard Business Publishing. 2. Dyson J. 2001. Accounting for Non Accounting Students (5th Ed.), Financial Times/Prentice Hall. 3. International Labour Office. 1991. How to Read a Balance Sheet: An ILO Programmed Book, International Labour Office. 4. Stickney C. P. and Weil R. L. 2002. Financial Accounting: An Introduction to Concepts, Methods, and Uses, South-Western College Pub. 5. Weekman P. 2003. Financial & Management Accounting (3rd Ed.) Financial Times/Pitman. Read More