Financial statements are also helpful in submitting the tax return of the year (Besley, Brigham, 2001). In basic terms financial statement is comprises on Profit & Loss Statement, Balance Sheet, and on Statement of cash flows. There could be several reasons which signify the fact that it is gravely essential for one to understand the business or the industry in order to understand the financial statements better. Some of them may be: 2. The type of information financial statements provides.
There are mainly three types of information is available in Profit & Loss Statement, Balance Sheet, and Statement of cash flows. All the statements have own importance. Profit & Loss Statement debates over the companys revenue generation power, cost behavior and structure and in the end on Net Income. The balance sheet provides an overview regarding the companys financial position. In the same time the balance sheet also discussed about the companys assets, liabilities and owners equity. Cash flow statement discussed over the companys operating, investing and financing activities during the year.
It also discussed on the in flow and outflow of the cash and also on the cash equivalents. 3. The limitations of financial statements. The limitations of financial statements are stated below: ¢ Financial statements are debates over the historical facts they cant address the trends like inflation, growth rates etc (Erich A. Helfert, 2001). ¢ The qualitative factors are not evaluated in the financial statements and often neglected because no organization discussed the qualitative factors in the monetary terms.
Like reputation of the company, employees performance etc (Erich A. Helfert, 2001). ¢ It is the reality that out dated information of the companys financial profile is not worthy especially when the companys management is willing to take more debt from bank (Garrison, 2004). ¢ Whenever the financial statements are presented with out the notes then all the reported figures are picture less. 4. The outside factors upon which the conclusions drawn from these statements are reliant.
The most relying outside factors that makes an impression on the financial statements are stated below: ¢ Frequently changes in the tax percentages make an impact on the firms net income, dividend, EPS, owners equity, stock price, etc (Besley, Brigham, 2001). ¢ Governments regulation on any appropriate business slight distorts the financial statements of the company (Besley, Brigham, 2001). ¢ Events happening after balance sheet dates like case filed in the court of law make a negative impact on the reported figures of the company (Garrison, 2004).
¢ Fluctuation the interest rate percentage makes an impression on the interest expense of the company and also on the prices of the bonds. 5. How items in common-size statements are presented. In order to create common size statements we express it in the form of percentages rather than dollar amounts. It is easier to understand that we take the differences of amounts year by year and divided that difference amount with the total amount. Lets assume: 2008 2007 Difference increase/ (decrease)
Cash $150,000 $100,000 $50,000 And Total Assets is $500,000. Then Difference Amount/Total Assets x 100 50,000/500,000 x 100 10%. Means there is an increment of 10% is reviewed from the year 2007 to 2008. 6. How ratios in ratio analysis are computed and used. The formula of some important ratios is stated below: ¢ Average collection period (in times) = Net Credit sales / Average debtors ¢ Inventory turnover (in times) = Cost of goods Sold / Average Stock ¢ Current Ratio = (Current Assets / Current Liabilities)
¢ Total Debt Ratio = (Total Liabilities / Total Assets) ¢ Return on Equity = (Net Income / Average Equity) ¢ Return on Assets = (Net Income / Average Total Assets) The uses of ratios are sated below: ¢ Dividend yield which expressed as a rate of return on the market price of the stock. ¢ Interest coverage ratio shows the debt servicing ability and capability of a company and also indicator of a companys ability to meet its interest payment obligations (Myers, Brealey and Marcus, 2001).
¢ Debt ratio shows the percentage of total asset financed by debt, from a creditor / banks view point, the lower debt ratio gives a positive signal to the creditor. ¢ Current ratio also suggest the firms liquidity position lower current ratio gives alarming and negative signal to the creditor that firm is financial crises and on the edge of financial crunch (Myers, Brealey and Marcus, 2001). 7. Why most financial analysts prefer ratio analysis to common-size statements. It is quite easy to assess the financial performance of the company at a glance. It is the shortest way to get an appropriate result.
Moreover, common size statement is slightly tenacious and complicated to examine the different accounting heads (Erich A. Helfert, 2001). Reference Besley, Brigham, Scott, Eugene F. (2001). Principles of Finance. Florida: Harcourt College Publishers. Brealey, Richard A. , Stewart C. Myers, Alan J. Marcus, (2001). Fundamentals of Corporate Finance. New York. McGraw Hill Helfert, Erich A. (2001). Financial Analysis Tools and Techniques: A Guide For Managers. McGraw-Hill. Noreen, Eric W. , Peter C. Brewer, Ray H. Garrison. Managerial Accounting. 11. 2004.