The backbones of business reporting

There are three basic financial statements:(1) Profit & loss account(2) Balance sheet(3) Cash flow statementThe profit & loss account:The profit and loss account (also referred to as the income statement) shows the results of the flow of activity and transactions and is designed to report the profit performance of a business for a specific period of time. The profit and loss account reports total revenue, total expenses and resulting net profit. The purpose of the income statement is to keep you informed of the income and expense status over a period of time. At the end of each year, this statement is closed and starts again with the beginning of the new fiscal year.

The Balance sheet:Balance sheet (also referred to as statement of financial position or condition) lists the assets owned by a business, the liabilities owed to others and the accumulated investment of its owners. It is a report of what the business’s resources obligations are at a stated time. The balance sheet provides information in determining the degree of financial risk.

Cash flow statement:Complementing the balance sheet and income statement, the cash flow statement (CFS), records the amounts of cash and cash equivalents entering and leaving a company. A positive cash flow is essential to a businesses ability to survive and prosper. The CFS allows investors to understand how a company’s operations are running, where its money is coming from, and how it is being spent.

There are different kinds of users of financial statements. The users of financial statements may be inside or outside the business. They are classified and detailed as follows:1. Internal UsersThe internal users are the individuals who have direct bearing with the organization.

• Managers and Owners: For the smooth operation of the organization the managers and owners need the financial reports essential to make business decisions. So as to provide a more comprehensive view of the financial position of an organization, financial analysis is performed with the information supplied in the financial statements. The financial statement is used to formulate contractual terms between the company and other organizations. A variable of the financial statement like the current debt to equity ratio is important in deciding the amount of long term capital that would be required to be raised. The financial statements of other companies can also provide investment solutions to different companies. Sometimes it becomes difficult to decide the right field in which financial resources may be canalized. In such situations the financial statements of other companies provide the appropriate guideline.

• Employees: The financial reports or the financial statements are of immense use to the employees of the company for making collective bargaining agreements. Such statements are used for discussing matters of promotion, rankings and increment.

2. External Users• Institutional investors: The external users are basically the investors who use the financial statements to assess the financial strength of a company. This would help them to make logical investment decisions.

• Financial Institutions: The financial statements are also used by the different financial institutions like banks and other lending institutions to decide whether to help the company with working capital or to issue debt security to them.

Government:• The financial statements of a company, is used by the government to analyze whether the tax paid by this company, is accurate and in line with their financial strength.

Financial statement analysis is the process of examining relationships among financial statement elements and making comparisons with relevant information. It is a valuable tool used by both internal and external users in their decision-making processes related to stocks, bonds, and other financial instruments. The goal in analyzing financial statements is to assess past performance and current financial position and to make predictions about the future performance of a company. Investors who buy stock are primarily interested in a company’s profitability and their prospects for earning a return on their investment by receiving dividends and/or increasing the market value of their stock holdings. Creditors and investors who buy debt securities, such as bonds, are more interested in liquidity and solvency: the company’s short-and long-run ability to pay its debts. Financial analysts, who frequently specialize in following certain industries, routinely assess the profitability, liquidity, and solvency of companies in order to make recommendations about the purchase or sale of securities, such as stocks and bonds.

Analysts can obtain useful information by comparing a company’s most recent financial statements with its results in previous years and with the results of other companies in the same industry. Three primary types of financial statement analysis are commonly known as horizontal analysis, vertical analysis, and ratio analysis.

Horizontal AnalysisWhen an analyst compares financial information for two or more years for a single company, the process is referred to as horizontal analysis, since the analyst is reading across the page to compare any single line item, such as sales revenues. In addition to comparing dollar amounts, the analyst computes percentage changes from year to year for all financial statement balances, such as cash and inventory. Alternatively, in comparing financial statements for a number of years, the analyst may prefer to use a variation of horizontal analysis called trend analysis. Trend analysis involves calculating each year’s financial statement balances as percentages of the first year, also known as the base year. When expressed as percentages, the base year figures are always 100 percent, and percentage changes from the base year can be determined.

Vertical AnalysisWhen using vertical analysis, the analyst calculates each item on a single financial statement as a percentage of a total. The term vertical analysis applies because each year’s figures are listed vertically on a financial statement. The total used by the analyst on the income statement is net sales revenue, while on the balance sheet it is total assets. This approach to financial statement analysis, also known as component percentages, produces common-size financial statements. Common-size balance sheets and income statements can be more easily compared, whether across the years for a single company or across different companies.

Ratio AnalysisRatio analysis enables the analyst to compare items on a single financial statement or to examine the relationships between items on two financial statements. After calculating ratios for each year’s financial data, the analyst can then examine trends for the company across years. Since ratios adjust for size, using this analytical tool facilitates inter-company as well as intra-company comparisons. Ratios are often classified using the following terms: profitability ratios (also known as operating ratios), liquidity ratios, and solvency ratios. Profitability ratios are gauges of the company’s operating success for a given period of time. Liquidity ratios are measures of the short-term ability of the company to pay its debts when they come due and to meet unexpected needs for cash. Solvency ratios indicate the ability of the company to meet its long-term obligations on a continuing basis and thus to survive over a long period of time. In judging how well on a company is doing, analysts typically compare a company’s ratios to industry statistics as well as to its own past performance.

The methods of analyzing the financial statements clearly show that at least 2 sets of financial statements (of two different years of the same company, or of the same financial year of two different companies of the same industry) are required. No comparison can be made with only one set of final accounts. So it is impossible to satisfy the needs of different users with a single set of published accounts.

Source:

Glautier, M W E. and Underdowns, B. (2007) Accounting Theory and Practice. (7th end) FT Prentice Hall.

http://www.answers.com/topic/financial-statement-analysisQ2. Cash flow is the lifeblood of any organization. Thus cash flow statements and not profit statements should be included in financial reports.

Ans2.

The statement of cash flows is one of the main financial statements. (The other financial statements are the balance sheet, income statement, and statement of stockholders’ equity.) The cash flow statement reports the cash generated and used during the time interval specified in its heading. The company chooses the period of time that the statement covers.

The difference between cash flow statement and the income statement is accrual accounting, which is found only on the income statement. Accrual accounting requires companies to record revenues and expenses when transactions occur, not when cash is exchanged. At the same time, the income statement, on the other hand, often includes non-cash revenues or expenses, which the statement of cash flows does not include.

Just because the income statement shows net income of $10 does not means that cash on the balance sheet will increase by $10. Whereas when the bottom of the cash flows statement reads $10 net cash inflow, that’s exactly what it means. The company has $10 more in cash than at the end of the last financial period. There fore it can be summarized that the net cash from operations as the companies “true” cash profit.

Because it shows how much actual cash a company has generated, the statement of cash flows is critical to understanding a company’s fundamentals. It shows how the company is able to pay for its operations and future growth.

Three Sections of the Cash Flow StatementCompanies produce and consume cash in different ways, so the cash flow statement is divided into three sections: cash flows from operations, financing and investing. Basically, the sections on operations and financing show how the company gets its cash, while the investing section shows how the company spends its cash.

Cash Flows from Operating ActivitiesThis section shows how much cash comes from sales of the company’s goods and services, less the amount of cash needed to make and sell those goods and services. Investors tend to prefer companies that produce a net positive cash flow from operating activities. High growth companies, such as technology firms, tend to show negative cash flow from operations in their formative years. At the same time, changes in cash flow from operations typically offer a preview of changes in net future income. Normally it’s a good sign when it goes up. However a widening gap between a company’s reported earnings and its cash flow from operating activities. If net income is much higher than cash flow, the company may be speeding or slowing it’s booking of income or costs.

Cash Flows from Investing ActivitiesThis section largely reflects the amount of cash the company has spent on capital expenditures, such as new equipment or anything else that needed to keep the business going. It also includes acquisitions of other businesses and monetary investments such as money market funds.

it is important for a company to re-invest capital in its business by at least the rate of depreciation expenses each year. If it doesn’t re-invest, it might show artificially high cash inflows in the current year, which may not be sustainable.

Cash Flow From Financing ActivitiesThis section describes the goings-on of cash associated with outside financing activities. Typical sources of cash inflow would be cash raised by selling stock and bonds or by bank borrowings. Likewise, paying back a bank loan would show up as a use of cash flow, as would dividend payments and common stock repurchases.

Because the income statement is prepared under the accrual basis of accounting, the revenues reported may not have been collected. Similarly, the expenses reported on the income statement might not have been paid. You could review the balance sheet changes to determine the facts, but the cash flow statement already has integrated all that information. As a result, savvy business people and investors utilize this important financial statement.

Here are a few ways the statement of cash flows is used.

1.The cash from operating activities is compared to the company’s net income. If the cash from operating activities is consistently greater than the net income, the company’s net income or earnings are said to be of a “high quality”. If the cash from operating activities is less than net income, a red flag is raised as to why the reported net income is not turning into cash.

2.Some investors believe that “cash is king”. The cash flow statement identifies the cash that is flowing in and out of the company. If a company is consistently generating more cash than it is using, the company will be able to increase its dividend, buy back some of its stock, reduce debt, or acquire another company. All of these are perceived to be good for stockholder value.

3.Some financial models are based upon cash flow.

Source:1.http://www.accountingcoach.com/online-accounting-course/06Xpg01.html#statement-of-cash-flows-wha#ixzz0ORY36RWJ2.http://www.investopedia.com/university/fundamentalanalysis/fundanalysis8.aspBibliographyBooksBerry A, Jarvis, R (2005) Accounting in a Business Context, (4th edn)Elliott, Barry and Elliot, Jamies (2008) Financial Accounting and Reporting, (12th edn).

Glautier, M W E. and Underdowns, B. (2007) Accounting Theory and Practice. (7th end) FT Prentice Hall.

Nebel, Bernard J.; Richard T. Wright (2007). Environmental Science (7th ed.).

Schulze, Hagen (1994). States, Nations and Nationalism. Blackwell Publishers IncWood, Frank and Sangster, Alan (2008) Business Accounting 1, (11th edn)Internethttp://www.investorwords.com/1207/creditor.htmlhttp://www.nolo.co