Financial statement analysis and interpretation

Financial Accounting

The reasons companies create and maintain accounting systems

Accounting is the language of business. The ability to record transactions is critical for companies in regards to keeping track of critical performance metrics. The subsequent management of revenues and expenses is critical for the sustainability of the business. Accounting systems, therefore, are needed for accurate assessment of business progress. Businesses create these systems to help facilitate their overall strategic objectives. For instances, if accounts receivables are high, management may be inclined to increase credit terms to discourage customers from borrowing. A natural reaction from this strategic move could possibly be an increase in customers paying in cash. Through tightening credit, management was able to avoid potential delinquencies while increase the cash on hand. These decisions can be made through accurate and timely accounting systems.

In addition, accounting systems can help businesses determine methods by which to improve operations. Aspects such as inventory turnover and expenses can be tracked using accounting systems. In many instances, investors demand a required rate of return for their investment in a business. Through proper accounting systems, management can better ascertain areas that may need improvement, ultimately helping to generate high returns. For example, financial firms are using accounting systems to reduce the overall cost structure of their businesses. Many large financial firms are announcing job cuts, expense reductions, or divestitures. All of which will help drive businesses earnings and investor returns. Accounting systems are need in these instances to help facilitate the decision making process

The basic structure of assets, liabilities, and stockholders' equity including definitions and relationships

Assets are resources used to generate cash for the business. It is an economic resource used to help create positive economic value. In regards to accounting, assets can be both tangible and intangible. Intangible assets often include aspects that can't be readily quantified such as a brand name. Liabilities are generally considered debts or obligations to other entities. These obligations generally take the form of loans from banks or other financial institutions. In some instances liabilities such as loans can be used to finance the acquisition of assets such as real estate. This is particularly advantageous to firms when interest rates are low. For example, firms may borrow at low interest rates, to fund projects that have a high rate of return. Stockholders equity is the claim of earnings by the most junior class of investor. The common shareholder has an interest in the assets of the company, after subtracting liabilities. This proportional interest in the earnings of the business is called stockholders equity. Lower liabilities, including loans outstanding, generally leave more earnings for the common shareholders. In addition, some companies may engage in the practice or purchasing their own shares with low cost debt, to enhance the earnings per share of the remaining shareholders.

The four basic financial statements

1) A balance sheet gives an overall picture of a company's financial situation by showing the total assets of a business. The balance sheet also includes liabilities and shareholders' equity. The balance sheet starts with current assets. Current assets are generally considered assets that easily be converted into cash. These assets are then ordered by liquidity with cash and cash equivalents being the first two line items. The balance sheet also includes accounts receivable, inventory and prepayments for insurance. Fixed assets are assets that will be retained in the business for longer than a year. These assets can be illiquid and include property, capital equipment. Short-term liabilities encompass accounts, wages and taxes payable within a year. Long-term liabilities are obligations that will be paid after a year, including mortgages and bonds. Equity refers to an owner's stake in a business for a sole proprietorship or partnership and to shareholder equity for a corporation.

2) Income statements indicate the revenue and expenses to generate the revenue over a specified period of time, generally a quarter. The bottom line of the income statement is net income of the business after paying out expenses. Company expenses generally include product acquisition, wages, advertising, taxes and capital losses. It is common practice for most corporations include earnings per share, EPS, on an income statement as well

3) A cash flow statement shows the amount of increase or decrease in cash that the company has on hand every quarter. This statement is particularly important for investors, as they need to determine the financial health of the company. Companies report their cash flow from operating activities, including the sale of products and services; investing activities, including the purchase or sale of capital equipment and property; and financing activities, including the sale of stocks and bonds or taking out a loan from a lender

4) In rare instances Companies may create a separate equity statement that shows the equity of shareholders or owners at the end of a financial period, which includes the value of each share plus gains or minus losses and the withdrawal of or addition to company funds on the part of owners and shareholders.

The effects of revenues, expenses, and dividends on the financial statements