A financial statement is a record of a company's financial transactions and position. It typically includes balance sheets, income statements, cash flow statements, and statement of shareholder's equity. These statements provide information on a company's financial health, performance, and liquidity.
According to John N. Myer, “The financial statements provide a summary of the accounts of a business enterprise, the balance sheet reflecting the assets, liabilities and capital as on a certain date and the income statement showing the results of operations during a certain period.”
1. Summarizing: Financial statements summarize financial transactions into a clear and concise format.
2. Historical: Financial statements provide information on past financial activity.
3. Standardized: Financial statements follow a set of accounting standards, which provide consistency across companies and industries.
4. Accrual-based: Financial statements are based on the accrual accounting method, which recognizes financial transactions when they are incurred rather than when payment is made.
5. Predictive: Financial statements can be used to make predictions about a company's future financial performance based on past trends and current financial conditions.
1. Relevance: financial statements should provide information that is useful in making economic decisions.
2. Reliability: financial statements should be trustworthy, accurate, and verifiable.
3. Comparability: financial statements should enable comparison of a company's financial position and performance over time and with other companies.
4. Consistency: companies should use the same accounting principles and methods from one period to another.
5. Materiality: financial statements should include only information that is material, or significant, to understanding a company's financial position and performance.
6. Understandability: financial statements should be presented in a way that is easy for users to understand.
1. Balance Sheet: Shows a snapshot of a company's financial position at a specific point in time, including its assets, liabilities, and shareholders' equity.
2. Income Statement: Reports a company's revenue and expenses over a specific period of time, showing the profit or loss for the period.
3. Cash Flow Statement: Shows the inflow and outflow of cash for a company over a specific period, including cash received from operations, investing, and financing activities.
4. Statement of Changes in Equity: Reports changes in a company's shareholders' equity over a specific period, including stock issuances, dividends, and retained earnings.
1. Decision Making: Helps stakeholders to evaluate the financial health and performance of a company.
2. Planning and Budgeting: Used to create future financial plans and budgets.
3. Compliance: Required for regulatory compliance and tax purposes.
4. Lending and Investing: Helps banks, investors, and lenders make informed decisions on whether to grant credit or investment.
5. Performance Evaluation: Facilitates performance evaluation and comparison with industry standards and competitors.
6. Shareholder Communication: Communicates financial information to shareholders, stakeholders, and potential investors.
10 Objectives of financial statements:-
1. Relevance: Provide information that is useful in making economic decisions.
2. Reliability: Provide information that is dependable and trustworthy.
3. Comparability: Provide information that can be easily compared with similar entities.
4. Understandability: Provide information that can be easily understood by the intended users.
5. Materiality: Provide information that is significant enough to impact decisions.
6. Timeliness: Provide information that is available in a timely manner.
7. Consistency: Present information in a consistent manner from period to period.
8. Neutrality: Present information in an impartial manner.
9. Substance over form: Present information in a manner that reflects the underlying economic substance of transactions and events.
10. Continuity: Assume that the entity will continue to operate in the future.
1. Historical Nature: Financial statements only reflect past events and may not be indicative of future performance.
2. Subjectivity: Financial statements rely on estimates and assumptions made by management, which can be subjective and prone to bias.
3. Limited scope: Financial statements only provide a snapshot of a company's financial position and do not capture all aspects of its operations and financial health.
4. Materiality: Financial statements may not include all material transactions and events due to size or significance thresholds.
5. Timeliness: There may be a delay in the issuance of financial statements, which can result in them being outdated and no longer relevant.
6. Inconsistencies: Differences in accounting policies, standards and practices can lead to inconsistencies and incomparability of financial statements across companies.
7. Reliance on Auditors: Financial statements are dependent on the accuracy of audit reports, which may be limited by the scope and resources of the auditing firm.
Financial statement analysis is the process of reviewing and evaluating a company's financial statements (such as the balance sheet, income statement, and cash flow statement) to gain an understanding of the company's financial health, performance and future potential. This involves examining historical data and trends, ratios and other metrics, to identify strengths, weaknesses and make informed investment decisions. The goal of financial statement analysis is to provide insight into the financial position, performance and liquidity of a company.
According to Myers, “Financial statement analysis is largely a study of relationship among the various financial factors in a business as disclosed by a single set-of statements and a study of the trend of these factors as shown in a series of statements.”
10 objectives of financial statement analysis are:
1. To assess the past performance and current financial position of a company.
2. To identify strengths and weaknesses in the financial performance and position of a company.
3. To forecast future performance and financial position of a company.
4. To provide information to stakeholders for investment and credit decisions.
5. To support management in decision making by providing information on the company's financial performance and position.
6. To identify any potential red flags or risks that could impact a company's financial stability.
7. To compare the financial performance and position of a company with its competitors.
8. To determine the efficiency and effectiveness of a company's use of its assets, liabilities, and equity.
9. To identify trends and changes in the financial performance and position of a company over time.
10. To provide insight into a company's financial performance and position for use in negotiating business deals and contracts.
1. Horizontal analysis: Comparing financial data over time, to detect trends and patterns.
2. Vertical analysis: Examining each item on a financial statement as a percentage of a base amount, typically total assets or total revenue.
3. Ratio analysis: Comparing relationships between different financial metrics, to assess liquidity, profitability, efficiency, and solvency.
4. Trend analysis: Examining historical financial data over several periods to identify patterns and make predictions about future performance.
5. Common-size analysis: Expressing each item on a financial statement as a percentage of a base amount, to facilitate comparisons between companies of different sizes.
6. DuPont analysis: Breaking down a company's return on equity into three component ratios to analyze sources of profitability.
1. Comparative statements:- Comparative statements are financial statements that present data for multiple periods side by side to facilitate a comparison between them. The purpose of comparative statements is to enable the analysis of a company's financial performance and position over time or in comparison to other companies. This type of analysis can provide valuable insights into the company's growth, profitability, and financial stability. Common examples of comparative statements include comparative balance sheets, income statements, and cash flow statements.
2. Common size statement:- Common size statement is a financial document that shows the relative size of each item on a financial statement (e.g. balance sheet, income statement) in relation to a common base figure, usually total assets or total sales. Each item is expressed as a percentage of the base figure, so changes in absolute dollar amounts are adjusted for changes in the size of the company, industry, or time period. This makes it easier to compare the financial performance and position of different companies or industries, or to compare the same company over time.
3. Trend analysis:- analysis is a statistical method used to analyze data to identify a pattern or trend over time. The objective of trend analysis is to find the direction (increasing, decreasing, stable) and magnitude of change in a set of data over time. It is used in various fields such as finance, economics, and marketing to help make informed decisions based on past data and predict future behavior.
4. Ratio analysis:- Ratio analysis is a financial tool that compares various aspects of a company's financial information to evaluate its performance, position, and solvency. It involves calculating and comparing financial ratios such as liquidity ratios, solvency ratios, profitability ratios, and efficiency ratios, based on a company's financial statements. The resulting ratios provide an understanding of a company's ability to meet its short-term obligations, generate profits, manage its assets and liabilities, and use its resources effectively.
5. Cash flow analysis:- Cash flow analysis is the process of reviewing and evaluating an organization's inflow and outflow of cash to understand its financial health and ability to generate positive cash flow. It helps to identify trends, manage cash balance and make informed decisions about investments, expenditures, and financing activities. The analysis is usually performed over a specific time period, such as a month, quarter or year, and considers various sources of cash such as operating activities, investing activities, and financing activities.
6:- Fund flow:- A Fund Flow Statement is a financial statement that shows the inflow and outflow of cash and cash equivalents for a company during a specific period of time, typically a fiscal year or quarter. It presents an overview of a company's financial health and helps to understand the company's ability to generate and use cash.
1. Reliance on historical data: Financial statements only provide information about a company's past performance, not its future prospects.
2. Subjectivity in accounting methods: Different companies may use different accounting methods that can impact the comparability of financial statements.
3. Non-financial information missing: Financial statements do not provide information on a company's reputation, brand, customer base, or market position.
4. Limited accuracy: Financial statements may contain errors or be misleading due to misstatements, fraud, or manipulation.
5. One-dimensional analysis: Financial statement analysis only provides a narrow view of a company's financial health, ignoring other factors that may impact its future prospects.
6. Incomplete information: Financial statements only provide limited information on a company's liabilities and future obligations.
7. Industry differences: Different industries have unique financial characteristics that may not be fully captured by financial statement analysis.
Economic Value Added (EVA) is a financial performance measure that calculates the difference between a company's net profit after taxes and its cost of capital. It provides a comprehensive view of a company's profitability by taking into account both its operating efficiency and the cost of the funds invested in its assets. A positive EVA indicates that a company is creating value for its shareholders, while a negative EVA suggests that it is destroying value. EVA is widely used by companies and investors to assess the economic performance of a business and make informed investment decisions.
Economic Value Added (EVA) is a financial performance metric that measures the amount by which a company's operating profit exceeds its cost of capital. The advantage of EVA is that it provides a clear and simple measure of a company's financial performance, taking into account the cost of both debt and equity financing. EVA is considered an important tool for companies and investors to evaluate the value created by a company. Other advantages of EVA include:
1. Focuses on profitability: EVA provides a measure of a company's profitability after taking into account the cost of capital.
2. Better decision making: EVA helps companies make better investment decisions by considering the cost of financing and the potential return on investment.
3. Improved communication: EVA is a straightforward and easily understood metric, making it an effective tool for communicating the value created by a company to stakeholders.
4. Aligns interests: EVA provides a common language and framework for aligning the interests of management and investors around a shared goal of creating economic value.
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