Free Term Paper On Financial Ratios
Balance sheet can be defined as a financial statement which shows the financial position of a business as at a particular time. It has two parts one of them shows all the assets that the company owns and the other side shows the liabilities as well as the shareholder’s equity. (Barry J. & Epstein, E 78).A balance sheet is always prepared as per a certain date. For instance, a balance sheet dated 31st December 2000, shows the financial position of the business for the year 2000.In simple terms, a balance sheet may be defined as a financial statementwhich shows the sources of funds (liabilities) and how these funds are being used (assets).The general equation is Total Assets = Total Liabilities + Total Capital. It contains the following features: assets, Liabilities and capital/Equity. (Barry J. & Epstein, E 123).
Assets are what the company owns at a particular time. They can be splited further to fixed assets which include machinery and premises and also current assets which include cash and stocks.
Liabilities can also be divided into current liabilities such as short term debt and long term liabilities such as a five year loan. (Watanabe, I 451).
At any given time, both sides of the balance sheet should be equal. That is assets should balance the liabilities to show that a business is doing well. One of the importances of a balance sheet is that it depicts a good image of financial stand of a firm. (Barry, J. & Eva, K 33). It is also a summary of a business’s balances which entails its assets, liabilities as well as equity. This shows that it is easier to understand how a business does without having to make a lot of financial calculations. Most importantly, a balance sheet can be used to attract investors into a firm. This is because it summarizes how a firm is doing financially at any given time. This gives investors easy time to make decisions. (Barry, J. & Eva, K 28).
Through this statement, a shareholder is in a position to identify a company’s earning capacity in the future. This is very important in that an inventor can know how the business would meet its debt. (Barry, J. & Eva, K 97). Two balance sheets drawn from different years in the same company can be compared and a conclusion on how the company is doing can be drawn. For instance, if accounts receivable continues to increase, it can translate to the fact that not all revenues converts to cash flow.
It helps the owner of the business to quickly get to know the capabilities and strengths of a business. Balance sheet can be used to identify and analyze trends in particular in the area of receivable and payables. One can depict whether the business can expand in the near future.
Income statements which are also known as profit and loss accounts are financial statement of a company prepared at a given time and they show how the company is doing in terms of profit and loss. (Watanabe, I 400). The main elements of an income statement include; Revenues, This section of the statement shows all the monies earned for a period of time by the company. ; Expenses; this section of the statement shows how much money a company has spent for a specific period of time. Some of these expenses may include; general and administration expenses as well as depreciation and amortization. (McDonald, F. & Burton 178). Thirdly, Profit or Loss; this section shows the cost subtracted from revenues. This section is the most important since it informs the investors on the amount of money they should save or invest after all the costs have been incurred.
Income statement have got different portions as discussed above and these portions can help the inventors to deduce the performance of their company for a specific time .They can also know the strengths and capabilities of a company from time period to time period for the purpose of evaluating improvement.(Daniels, P 97). These particular statement is important in the sense that if a business need to expand and the cost cannot be met by internal funds, then the potential investors will look at the income statement in order to make decision whether to invest their money in the business or not. If they see the company as a better investment opportunity through the income statement, they can go a head and do the investment. Therefore we can say that income statement can be used to attract foreign as well as local investors. (Daniels, P 191)
Income statement assists the investors and creditors to evaluate the past performance of the company financially as well as future financial performance. By so doing, they can use their findings to asses the future cash flow capability of the company by looking at the report of the income and expenses.
The income statement is a good document where the investors or the owners of the business can measure the profitability of the business as per a specific period. It is very easy to evaluate the company’s financial state of affairs using this type of financial statement. (Daniels, P 47).The government is also interested in this document because they use it to quantify the amount of tax to be imposed to any business.
Financial institutions such as banks and other lending companies use income statement to decide whether to give out loans or not while this statement is presented to them. (Helfert, G & Erich A. 56). A company can use this statement to acquire a fresh working capital to extend their debt securities to cater for expansion and other important expenditures.
The media and the general public are also interested in this statement for various reasons. The public need it so that they can buy stock of the company incase the company exist in the stock exchange market.(Helfert, G & Erich A. 78).While the media need it in order to make analysis and pass the information to the people on where to make investments.
The cash-flow statement is basically used to bring back the accumulation based on ac counting used to prepare both the balance sheet and the income statement back to cash. Just like the income statement, cash flow statement is also used to measure financial activities of a company as per a given period of time. (Helfert, G & Erich A. 77).This statement is affected by any changes effected in the balance sheet.
The cash flow statement has got four major divisions. Firstly, there is net cash flow from operating activities. These are the daily activities of the business that do either require cash or generate it. They may include cash collected from customers or cash paid to suppliers.secondly, there are net cash flows from investing activities. (McDonald, F. & Burton, F 233). The investment is generally done by the management which for instance might include purchase of machines. Thirdly, there are net cash flows that result from financing activities. Financing activities are purely those external uses or spending of cash which affects the cash flow of the company. Finally, net change in cash and marketable securities. The first three calculations are used to determine this fourth factor. This number is then checked against the figures on the balance sheet from time to time to give verification that the previous calculation has been accurately done. (McDonald, F. & Burton, F 238).
The statement of cash flow informs the investor on how much money a company generates. From there, several conclusions can be drawn; one of them being whether the company is viable to stand any financial downfall. Through this document, the investors get to know the financial health of the company. It gives the accountants easy time to conclude whether the company is able to pay his employees and meet other immediate expenditure. (McDonald, F. & Burton, F 231). This document is also used by the lenders and creditors to build their confidence on the company since they can find out whether the company is in apposition to pay them back. Investors who would wish to commit their money in the business also through cash flow statement can see if the company is financially viable. Contractors and potential employees can also find out if the company will afford compensation. (McDonald, F. & Burton, F 88).
Just like in the case with the income statements, cash flow statements are needed by financial institutions such as banks and other lending companies to decide whether to give out loans or not while this statement is presented to them. Similarly, a company can use this statement to acquire a fresh working capital to extend their debt securities to cater for expansion and other important expenditures.
Relations between the statements
The financial tools used to assess a company and its operations are; the balance sheet, income statement and cash flow statement. A balance sheet at time may not reflect the true picture of the value of a company. (Harry, I. & Wolk, J 65). This is because it only shows the historical cost and do not put into account the appreciation or depreciation of the assets. Therefore the remaining two statements can assist when it comes to depreciation or appreciation of assets.
Data retrieved from the balance sheet, income statement and cash flow statements can be manipulated to come up with figures which make better understanding of the business.( McDonald, F. & Burton 78). For instance, financial rations can be calculated from these statements and it come clear on the mount of debt a company has used to finance growth.
Balance sheets and income statements are used to provide financial reports to potential lenders such as banks. (Harry, I. & Wolk, J. 99).Important decisions are being made by the owners and managers of a business by the help of the business statements. Using the relationship of the three discussed statements, several financial ratios can be calculated to provide the managers with a more detailed understanding of the business.
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