Your college-mate, Adam, who studies in an Engineering faculty thinks that preparing the financial statement annually is a waste of time. As an Accounting student, you do not agree with Adam’s opinion. Explain to Adam the purpose of preparing a financial statement.
Nowadays, there are a lot of demands that will be made for its financial statements throughout the existence of a business. Profitability, financial health, as well as success of a particular organization conclude the main key of information of a financial statement. The financial numbers in a financial statement also supply a measure of the failure or achievement of its business strategies as well of its current management. There are four main factors of financial statement which are balance sheets, income statements, cash flow statements and retained earnings. Each of these statements is a part of the structure for the financial statements. Generally Accepted Accounting Practices or also can be known as GAAP is the structure of it. When it comes down to a company financial stability, each of a financial statement has a purpose and reason as well as to provide detailed information.
In another way, financial statements are also some sorts of like a crucial reports. For a company’s stockholders, board of directors, its managers and to the employees which also includes labor union, the statement shows them how a business is doing are a somehow very beneficially internally. They are also crucial to government agencies which are responsible for regulating and taxing, to stockbrokers and investment analysts, to lenders such as credit rating agencies and bank and not forgotten towards prospective investors externally.
A lot of strategic thinking goes into the way businesses present their performance date given the competing demands for attention. Whole collecting financial worksheets for another group and comprehensive reports, they may have to prepare concise, straightforward data summaries for one group of investors. Tracking various factors such a liquidity and solvency are the main purpose for investors using financial statement.
The main use of a financial statement is to make sure a business establish the results of its operations over a certain period of time as well as to verify its worth at a specific date. Business people always prepared financial statement to help them in evaluating their financial health. In the other hand, it is also crucial to supply specific financial statement upon the demand of a supplier or even banker. When a business is involved, tax returns require a financial statement. In-house monthly financial statement can be in any form that is acceptable or easy to the management. However, they need to be in a standard format and the need to follow a certain rules of preparation when the financial statement provided to outside parties.
A basic set of financial statement will also include of an Income Statement which generates the profit or loss over a period of time, a balance sheet which conclusion of the Assets, Liabilities and Equity of the business at a specific date. Occasionally, a Cash Flows Statements may also be generated, which concludes the disbursements and receipts of cash during the period of time. For management and owners, it’s a useful tool for them in order to supervise where the cash is really going.
By providing relevant and trusted financial information, the important objective of every financial statement is of assistance to the intended users in their economic decision making process. General Purpose Financial StatementsA are prepared for general users keeping general needs in mind but not able to supply all such information that users may want. Special Purpose Financial Statements are prepared keeping the information needs of some users and also may supply such additional data which normally general purpose financial statements may not contain.
The special purpose financial statements tends to highlight a certain area as well as to supply information in that regards. It may be or may not be prepared under the same accounting structure which is used to prepare general purpose financial statement. Financial statements prepared for bank to request for a loan is one of the good examples.
There are three aspects that the general Purpose Financial Statements provide information which are:
Can be explained of how business activities had affected the investors’ stake in the entity. Users need this information to evaluate whether the entity has made satisfactory contribution towards their investment or not. Users are also eager to know how much cash and cash equivalents have been generated and where they have been use. Like for example, the cash flow. This information is obtainable in the form of statement of cash flow and statement of changes in equity.
All of these statements should not be observed in isolation as they are linked together and in order to get the full impression of the business, people must look at them as a whole as well as in totality instead of considering them differently even through each of these statement serves a particular objective.
Is the entity which relates to the entity’s skill to use the economic resources that are available in a profitable manner as well as how good entity managed to general considerable cash flows by using this resources. Statement of comprehensive Income is used for this information presented.
Is the entity which can be explained by the position of the business liabilities and assets as well as how entity uses the resources at its disposal in order to survive the changing business solvency and requirements. Statement of Financial Position which also recognized as Balance Sheet is used for this information presented.
There are four different kind of financial statements. These statements are compulsory to be audited by the authentic, reliable and trusted, efficient audit firms in order to avoid exploitation of numbers. After a thorough study of an organization records, then the accounting firms only audited the statement. The four important types of financial statement as shown as below:
Balance Sheet, is one of the four basic financial statement required by IFRS and GAAP. The purpose of this balance sheet statement can be explained as a better picture of a certain organization financial position. The balance sheet is the one and only statement that applies to a single point in time out of the other three statements.
Usually, a normal balance sheet contained three parts such as assets, liabilities as well as shareholder’s equity. The asset subcategories are normally written down first and naturally listed in the order of liquidity. Assets are then followed by the liabilities. Shareholders’ equity or as the new assets/net worth of an organization are the main difference in between the assets and the liabilities. Assets are equal to the sum of liabilities and shareholders’ equity. A good example of items recorders as assets can also include plants and equipment, property and account receivable and for the example of liabilities includes long term bonds and account payable.
Balance Sheet came from the fact that the total assets must always be in balance with the sum of liabilities and shareholders’ equity. An organization will have to finance its assets by either borrowing money from other sources in the form of liabilities or collecting the money from shareholders. The main formula for balance sheet is:
On a business’ cash generating ability, the income statement is a very straightforward and simple report. It’s provides crucial information on the financial performance of the business that shows when expenses are incurred and when sales are made. Capital, revenue, cost of goods and expenses are example of information withdraw from the numerous financial models.
The income statement is able to let an organization know how much their organization making, which can be either in profit or even loss during the year by subtracting the cost of goods and expenses from revenue to arrive at net results by combining these elements. Due to the income statement do not show when the expenses are paid or when revenue is collected, therefore it differs from a cash flow statement. In the other hand, it shows the predictable profitability of the business over a certain period of time covered by the plan. The income statement must be produced on a monthly basis during the first year, followed by quarterly for the year two and annually for the third year for a business plan.
In the following manner, below is the financial projection in Income Statement:
A Includes all the income made by the business of an organization.
Include all the costs that are linked to the sale of products in the inventory.
Its the difference in between revenue and cost of goods. It can be uttered as a percentage or in dollars or potentially even both. As a percentage, the margin of Gross Profit is constantly affirmed as a percentage of revenue.
Includes labor spending and all overhead related with the operations of the business.
Sum of operating expenses and cost of goods.
The difference between gross profit margin and total expenses. The net income depicts the business’ debt and capital capabilities.
Show the downfall in value of capital assets that are used to produce profits. It’s also used as an pointer of the stream of money into new capital and the basis for a tax deduction.
Includes the capacity of a business to repay its obligations.
Includes all interest payable for debts, both long-term and short-term.
Includes all taxes on the business.
Show the company’s real bottom line.
The basic equation on which an income statement is based is:
Cash flow statement is basically a report that reflects of the sources of organization cash and how the cash was used over a certain period of time. However, it doesn’t include the non- cash items such as depreciation. To determine the short-term viability of an organization when it comes to paying the bills, this method is very useful. A lot of analysts propose that an entrepreneur study a cash flow statement at least every quarter of the year because the management of cash flow is very important towards the small businesses and for business as well.
The income statement that was mentioned earlier is the same with the cash flow statement because it records down an organization performance over a certain period of time. The cash flow statement shows the exact amount of money that an organization produce while the income statement also takes into account of some non-cash accounting items such as depreciation. Therefore, that’s the main difference between those two statements. Cash flow statement also show how an organization have performed in handling the inflows and outflows of their cash while also come in handy, which give a bigger and better view of an organization ability to pay their creditors as well as their financial growth.
According to the accounting standards, it is not wrong for an organization that is shown to be profitable to go under if there isn’t sufficient cash on hand to pay their utilities. Operating cash flow ratio, which can be explained of comparing the amount of cash generated to outstanding debt, prove the company skill to service their interest payment and loans. If a slight drop in an organization quarter cash flow would destroy their skill to make a loan payment that the organization is in a very danger position that one with less net income but a stronger cash flow level.
There is not much an organization could do in order to manipulate its cash situation unlike the numerous ways in which reported earning can be offered. The cash flow statement will always be accurate whether the organization has cash or not. In order to recognize an organization overall health, an analysts will observe closely at the cash flow statement of any organization.
The portion of net profit or net income which are abstract from the income statement that never been paid out as dividends are called retailed earnings. Therefore, these earnings are then used for some purpose or reinvested in an organization. It can be also used to further develop the organization through some investment for example like paying off debt, investment in development or even research and so on.
Retained earnings are cumulative. They symbolize the past and present earnings of an organization that have been reinvested in the company. Under the Shareholder’s Equity section of the balance sheet, the retained earning account show the retained earnings since the establishment of the organization. It is also cumulative revenues from undistributed profits.
Most of these analyses engage comparing retained earnings per share to profit per share over a certain period of time. They also sometimes evaluate the amount of capital retained to the change in share price during that same period of time. The return management generated on the profits it plowed back into the business are the methods that use to measure. A method that accounts for taxes is also used in this vein in the look through earnings.
Developed industries often retain a large sum of their earnings than other industries because they need more asset investment to function or even operate. Older organization may report drastically higher retained earnings than those newer organization in the same industries because retained earnings symbolize the sum of profits lesser dividends since their establishment. This is the main reason of why the comparison of retained earnings is very hard but usually the most meaningful among other organization of the same time of establishment while the meaning of "low" and "high" retained earnings should be made within this circumstance.
Just take an example of when Ali Maju Sdn Bhd, retained 72 percent of its net income for its retained earnings account and eventually gave out 50 percent of its net income as dividends to its shareholders.
Your college-mate, Adam, who studies in an Engineering faculty thinks that preparing the financial statement annually is a waste of time. As an Accounting student, you do not agree with Adam’s opinion. Explain to Adam how the financial statement could help the user of the financial statement in their decision-making.
Financial statements of a company or individual are the documents that reflect the historic financial information of the entity. This includes a detailed and accurate record of the assets and liabilities as well as the income and expenses and also the cash flow of the entity. These documents are written records that quantitatively explain the health of unit represent in the statements.
Financial statement are decision-making tools because it helps use to see a better and clearer idea of how an organization financial position. Financial Statements also show business trends, the rate at which you are paying creditors and any cash flow problems and also the rate at which you are collecting receivables. Take an example of accounts reports show whose is paying on time or can even be 30 days late, 60 days late or up to 3 months late. By using this financial statement, we can determine which customers or supplier that is in a good standing or that are in need of collection efforts or have uncollectible open invoices.
Let’s just assume that an invoice has not been paid within the period of six months, after collection efforts, this is probably an uncollectible debt. Accounts payables reports let you know what is owed to whom and when. We are also able to generate the reports to further let us know the value of the inventory and what our inventory levels are. Not only that. We can produce a report to answer any question that we have about our business cooperation related to what we owe, what we own as well as how much money that our company makes, in a period of time which can be monthly, or yearly. These are basically the questions that we need to answer as we make strategic decision on how to make our business to be successful without losing any money in the near future.
In addition to that, we need financial statement to calculate our quarterly state as well as federal tax obligation which include sales and annual taxes. A sales report that separates taxable sales from nontaxable sales will give us the information that we need to pay the state the sales taxes that we collected from our customers. Federal tax obligation also include payroll related taxes and annual taxes. A payroll liability report is not only to the federal government but also for benefits but also outline all our payroll-related obligations; we must be able to give documentation of the information reported in our tax fillings if we are ever audited.
Beginning with the primary financial statements and any additional statements auditors’ request, acceptable documentation is financial statements. We also must be able to back up thee statements with hard records such as pay stubs and receipts. In order to prepare both state and federal annual taxes, we have to start with the primary financial statement. We also may need to find out that we need to run additional reports to produce the specific information that we need to fill out our tax forms.
First of all, to financial accounting whose final products are financial statements. However from the user’s aspects and from the aspects of the scope of business, we distinguish the following types of accounting: financial accounting, cost accounting and managerial accounting. We usually say that cost and managerial accounting ensure different information for internal users and financial accounting ensures synthetically and quality information needed for preparing the financial statements for external users. Nevertheless, in the context of measuring the entire business quality, financial accounting is also directed towards internal users.
chart.pngFigure 2- FINANCIAL STATEMENT
The most important financial statements that we must consider when examining the entire business quality and making decision for the future are:
1) Balance Sheets
2) Income Statements
3) Cash Flow Statements
4) Retailed Earnings/ Changes In Owners
We need to analyze the financial statement in order to improve the usage of financial information in the context of the decision making process, In that context, we only can describe financial statement analysis as the process where we convert data from financial statements into usable information for business quality measurement by different analytical techniques which is very important in the process of rational management. Since we try to ensure company’s development and existence on the market, it is very significant in the context of future business management to know the current level of business quality. Financial statement analysis comes before the management process that is before the process of planning which is the component of the management process. Planning is very important for good management. Good financial plan has to consider all company’s strength and weaknesses.
The task of financial statement analysis is to recognize good characteristics of the company so that we could use the most of those advantages, but also to recognize company’s weaknesses in order to take corrective actions. We can say that management of the company is the most significant user of financial statement analysis.
In the process of financial statements analysis, it is possible to use the whole range of different instruments and procedures. First of all, it considers comparative financial statements and the horizontal analysis procedure together with structural financial statements and the vertical analysis procedure. By horizontal analysis which is based on the comparative financial statements we try to examine the tendency and dynamics of changes of particular basic financial statements positions. We estimate business efficiency and security of the company on the basis of observed changes. On the other hand, structural financial statements are the base for vertical analysis which allows insight into financial statement structure. Financial statements structure is very significant in the context of business quality.
By financial statement analysis we get acquainted with the business quality, but the questions of the analysis are not solved by horizontal and vertical analysis procedures of balance sheet, profit and loss account and cash flow statement. In the context of measuring business quality on the basis of financial statements, the most significant are different financial ratios formed from basic financial statements
Financial Statements supply helpful information to a variety of users:
In the need of Financial Statement to have the review of capability of investing into an organization. Based on the statement, they also could have an idea of what the future dividends will be based on the earnings disclosed. Risks related with the investment may be gauged from the statement like for example, fluctuating profit indicate higher risk.
They need Financial Statement to make decisions on whether to approve credit to a business or to give green light to a loan. They also need to review the financial state of an organization to decide of the chances of a bad loan. Their decision to lend must be heavily based with a enough asset base and liquidity.
In the need of Financial Statement to decide the effectiveness of the tax announced in the tax returns. They will also need to have an eye of the economic development through analysis of Financial of businesses from numerous sectors of the economy.
Use Financial Statements to assess whether a supplier has the resources to ensure the steady supply of goods in the future. This is especially vital where a customer is dependant on a supplier for a specialized component.
Need Financial Statements to assess the credit worthiness of a business and ascertain whether to supply goods on credit. Suppliers need to know if they will be repaid. Terms of credit are set according to the assessment of their customers’ financial health.
Need Financial Statement in order to evaluate of their performance towards with their enemy organization as well as to learn and create strategic to advance their competiveness.
Need Financial Statement to handle the affairs of the organization by taking crucial business decision making and monitoring the financial performance and positions.
In the need the use of Financial Statement in order to evaluate the organization profitability and its’ effects on job security and also their future remuneration
Need Financial Statement to review the dangers, return as well as risk towards their investment in the organization. Also decide whether to or not to invest in the company based on the analysis.
Like to know more about the property of an organization on the economy, surroundings as well as the local community.
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