ACC 10707 Accounting for business
“Defining the three important financial statements has made analysts’ life simpler by ensuring consistency in reporting”. Analyzing a business’s performance and standing can be adequately done using financial statements.
Kunal Sharman
SHTM 2012
Institute for international management and technology
Oxford Brookes University
Ms.Garima Gupta
“Defining the three important financial statements has made analysts’ life simpler by ensuring consistency in reporting”.
A collection of facts and figures which are organized in a proper and systematic accounting procedures. Financial statements convey an understanding and content of financial data of an organization. According to john Hampton a financial statement is an organized collection of data according to logical and consistent accounting procedures. The aim is to convey an understanding of financial aspects of a firm. This essay will tell us about what are the three important financial statements and how these three important financial statements has made analyst life simpler by ensuring consistency in reporting.
Balance sheet, income statement and cash flow statement are the three important financial statements. Balance sheet:
A Balance Sheet is a financial statement that shows the financial position at a given date. Balance sheet includes a company's assets and liabilities. Assets are what we own and these are of two types; fixed asset and currents assets. Current assets include cash at bank, stocks, debtors and prepayments. Fixed assets include land and buildings, furniture and equipments. Long-term investments include share and deposits. Liabilities are what we owe and liabilities are of two type’s current liabilities, fixed liabilities, shareholder funds and long-term borrowings. Current liabilities include creditors, accruals and bank overdraft. Fixed liabilities are of two types’ shareholders funds which include share capital, reserves and retained profits. Long-term borrowings include loan from bank. The balance sheet always balances assets and liabilities that’s why it is called balance sheet. Balance sheet gives an idea that what the company owns, owes and the amount invested by the shareholder’s. Assets= liabilities + shareholders equity.
Income Statement:
The income statement includes all the income and revenue expenses that the business has incurred during a particular year. Revenue expense compared with revenue expenses to calculate profit or loss for the year. Income statement shows gross profit and net profit of a company in a particular year. Which is calculated by sales minus cost of good sales gives gross profit and after reducing cost of cost of expense from gross profit gives net profit. Income statement also known as the “profit and loss statement”. It is one of the three major financial statements. The income statement consist of two parts i.e. is operating and non-operating sections. The portion of the income statement that deals with operating items is interesting to investors and analysts alike because this section discloses information about revenues and expenses that are a direct result of the regular business operations. For example, if a business creates sports equipment, then the operating items section would talk about the revenues and expenses involved with the production of sports equipment. The non-operating items section discloses revenue and expense information about activities that are not tied directly to a company's regular operations. For example, if the sport equipment company sold a factory and some old plant equipment, then this information would be in the non-operating items section. Cash flow statement
Cash flow statement shows the main cash movements that are inflows and outflows that have occurred in a business over a period of time. It divides the activities that make/spend cash into operating, financing and investing. Cash flow statement gives a framework to reconcile the profits to cash for a company. Cash flow statement does not show whether the business is going in profitable, but it shows the cash position of the business at any point in time by measuring revenue. Terms which are shown in cash flow statement are cash, cash sales, receivables, other income, total income, merchandise, direct labor, overhead, taxes, capital, loan payments, total expense, cash flow and cumulative cash flow. There are two types of method from which cash flow statement can be prepared; indirect method and direct method. Direct method- It reports major classes of gross cash receipts and payments Indirect method- in, indirect method net income is uses as a starting point then adjustment should be made for all transactions for non-cash items, then adjust from all cash-based transactions. An increase in an asset account is subtracted from net income, and an increase in a liability account is added back to net income. But if the cash flow statements are prepared by direct and indirect method then profit which would come out will be the same from both the method Cash Flow Statement provides a framework to reconcile the profits to cash for a company. While preparing a cash flow statement, start with the ‘profit after tax’ figure. For example, if a company lands a major contract, this contract would be recognized as revenue (and therefore income), but the company may not yet actually receive the cash from the contract until a later date. While the company may be earning a profit in the eyes of accountants (and paying income taxes on it), the company may, during the quarter, actually end up with less cash than when it started the quarter. Even profitable companies can fail to adequately manage their cash flow, which is why the cash flow statement is important: it helps investors see if a company is having trouble with cash.
Roles of analyst
A business analyst is a person who analyzes the ideal organization and design of system, including businesses, departments and organization. The main role of analyst is to analyze the financial statements such as balance sheet, cash flow statement and income statement/ profit and loss statement of a particular company and give advice to shareholders that to continue holding the shares of a company or not. They are mostly hired by mutual and pension funds firms and for other business to help their clients to make successful investment decisions. One of the duties of an auditor is to make sure the consistency principle is being followed because, without this, any change might make correct interpretation of the financial data impossible.
Consistency principle
Consistency principle states that any accounting method once adopted by a company for a period of time unless the company has a very strong reason to change the method. In other words, the readers of a company’s financial statements can presume that the same rules and measurements were followed in all of the years being reported. If a change is made to a more preferred accounting method, the effects of the change must be clearly disclosed for example if a straight line depreciation method being followed by a company and all of a sudden company shifts to WDV method to increases the book value of a particular item. Consistency principle is one the four major principles that are used for estimating the project cash flows. Stability principle:
The idea of reliability in records means that accounting techniques once implemented must be used regularly in future. Also same techniques and techniques must be used for the same situation. It indicates that a company must keep from changing its accounting plan unless on reasonable reasons. If for any legitimate factors the accounting plan is changed, a company must reveal the characteristics of modify, the factors for the modify and its effects on the items of fiscal reports. Consistency idea is important because of the need for assessment, that is, it allows traders and other users of fiscal reports to easily and properly compare the fiscal reports of a company. Thus reliable confirming makes the work uncomplicated for the experts. (www.accountingexplained.com)
Conclusion
so through the medium of this essay it is very clear that analyzing a business performance and standing can be adequately done by using financial statements because the exact numbers in the financial statement give a clear idea to how the business will do or make profit in next coming years that for future it will go in profit or it will go in loss and analyst would tell shareholders to invest their money in that company or not and these financial statements also give a idea to analyst that why the business is not making profit up to the expectations for example through income statement if the gross profit is increasing of a particular company but their net profit is not increasing so after looking income statement analyst will conclude that there cost of expenses is high so analyst will tell these companies to reduce their cost of expenses.
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