TASK 4 4.1 discuss the main financial statements Financial Statements represent a formal record of the financial activities of an entity. These are written reports that quantify the financial strength, performance and liquidity of a company. Financial Statements reflect the financial effects of business transactions and events on the entity. Four Types of Financial Statements: The four main types of financial statements are: Statement of Financial Position Statement of Financial Position, also known as the Balance Sheet, presents the financial position of an entity at a given date. It is comprised of the following three elements: Assets: Something a business owns or controls (e.g. cash, inventory, plant and machinery, etc) Liabilities: Something a business owes to someone (e.g. creditors, bank loans, etc) Equity: What the business owes to its owners. This represents the amount of capital that remains in the business after its assets are used to pay off its outstanding liabilities. Equity therefore represents the difference between the assets and liabilities. View detailed explanation and Example of Statement of Financial Position Income Statement Income Statement, also known as the Profit and Loss Statement, reports the company’s financial performance in terms of net profit or loss over a specified period. Income Statement is composed of the following two elements: Income: What the business has earned over a period (e.g. sales revenue, dividend income, etc) Expense: The cost incurred by the business over a period (e.g. salaries and wages, depreciation, rental charges, etc) Net profit or loss is arrived by deducting expenses from income. The movement in cash flows is classified into the following segments: Operating Activities: Represents the cash flow from primary activities of a business. Investing Activities: Represents cash flow from the purchase and sale of assets other than inventories (e.g. purchase of a factory plant) Financing Activities: Represents cash flow generated or spent on raising and repaying share capital and debt together with the payments of interest and dividends. The movement in owners’ equity is derived from the following components: Net Profit or loss during the period as reported in the income statement Share capital issued or repaid during the period Dividend payments Gains or losses recognized directly in equity (e.g. revaluation surpluses) Effects of a change in accounting policy or correction of accounting error.
4.2 compare appropriate formats of financial statements for different types of business
Business financial statements show where a company’s money came from, where it went and where it is now. Owners and CEOs use these statements to manage a business, bankers to check its creditworthiness and investors to gauge its potential for dividends and growth. Financial statements must be accurate, reliable and timely. “Types” of financial statements can refer both to the kind of information they contain and how rigorously they are prepared, according to Generally Accepted Accounting Principles, or GAAP. Financial Statements by Information Type • The balance sheet provides a snapshot of the company’s financial position at a point in time, such as year-end. It shows what the company owns (assets) and what it owes (liabilities and net worth) at that point in time. The “bottom line” of a balance sheet is always assets = liabilities + net worth. An income statement shows how much revenue a company earned over an accounting period, such as a year or a quarter, and the costs and expenses associated with earning that revenue. The income statement’s “bottom line” shows whether the business was profitable or lost money for the period. The statement of cash flows summarizes a company’s “lifeblood,” its cash inflows and outflows during a given accounting period, indicating whether cash holdings increased or decreased. Businesses generate cash from operating, investing and financing activities and require it for paying expenses, repaying loans and purchasing assets. The statement of owner’s equity explains changes in retained earnings during the accounting period in question. Retained earnings appear on the balance sheet and represent the difference between retained income and withdrawals or dividends. Financial Statements by GAAP Type • Internal financial statements are those prepared by the company and are considered of “lowest” quality in the GAAP hierarchy. While internal statements may suffice for management purposes, bankers and investors cannot prudently rely on them. Compiled financial statements are those prepared by a Certified Public Accountant (CPA); however, they rely solely on information provided by the business client. Because they are CPA-prepared, banks and other lenders look on them more favorably, but not by much since they give no assurance about the underlying information’s integrity. Reviewed financial statements are one step up from compiled statements because the CPA performs detailed inquiries into transactions and records and applies analytical procedures not done in a compilation. These reviews are more expensive because of the extra work involved; lenders generally feel more comfortable with them than compilations. Audited financial statements are at the top of the hierarchy because the preparing CPA vouches formally that they conform entirely to GAAP. All publicly-held companies are required to file audited annual and interim financial statements with the Securities and Exchange Commission (SEC). They are expensive. Private companies need at least three years’ worth of audited financial statements if they have many shareholders, or the owners want to sell the business, obtain credit or take the company public.
Financial Statement Frequency • Businesses should publish at least annual financial statements and quarterly interim updates. Projected financial statements, also called “pro formas,” take historical financial statements as their starting point and make highly educated guesses about the business’ future. They can be useful in strategic planning and discussions with creditors and investors.
4.3 interpret financial statements using appropriate ratios and comparisons, both internal and external