Introduction to Financial Statement Analysis (PDF)
Added on - 31 May 2021
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Financial statements are the most important documents of the company. It is a formal record ofthe financial activities and position of the business[ CITATION Itt09 \l 1033 ]. It includes incomestatement, balance sheet, statement of cash flows and statement of changes in shareholders’equity. Financial position reveals about the company’s assets, liabilities and equity at a givenpoint of time and income statement reveals about revenue and expenses, profits and lossesoccurred to the business during a given period of time. The purpose of financial statements is toprovide information about the result of operations, financial position and cash flow of anorganization. The information provided by financial statements is used by a variety of users totake decisions related to allocation of resources.Financial statements should only contain information related to businessthat has occurredor existed rather than reports and thoughts of the issuers about the future. It should only recordtransactions which are related to operations of business and has already occurred. Future eventsor transactions which may or may not occur in future should not be included in financialstatements as statements are not prepared on accrual basis[ CITATION OHa16 \l 1033 ]. Everythingthat is included in financial statements should be supported bydocuments which are consideredas an evidence of proof. Anything that has not occurred but document is prepared should not beincluded in financial statements as it will be misleading. Anything that is fictions and or does nothappen should not be included in financial statements. In preparing financial statements onlythose formulas should be used which consider events already occurred. It should not take intoconsideration events on accrual basis which may or may not happen as it is related to futurewhich is uncertain. It should consider reporting entity different and separate from all otherentities with which it is associated. It should treat business and businessman as separate entitiesin order to have a clear picture[ CITATION Aji17 \l 1033 ].It should not incorporate falseassumptions as it will lead to misleading statements. Assumptions can be correct or incorrect asper consequences so it should not be included. Statements are prepared for the users and itshould emphasize their needs rather than some other parties. It should be prepared in a mannerthat it is useful to users and if there is a conflict user’s interest should be considered first ratherthan other relevant parties. It should also obey all the rules of arithmetic[ CITATION Rak12 \l 1033 ].Financial statements should be prepared on cashbasis which means when revenue is actuallyreceived and payment is actually made. Nothing about future should be taken into considerationin order to determine the results and to compare it with past events so as to know the progress ofthe business. Only current events that actually occurred should be considered to know the exactposition and it should be compared with past reports soas to ascertain the differences and reasonsfor the same so that immediate steps can be taken to correct it. If differences are positive then itshould be further implemented[ CITATION Erd17 \l 1033 ].Only those assets should be included in financial statements which are actually assets.Assets which have been discarded or depreciated to its full value should not be included infinancial statements[ CITATION Wey04 \l 1033 ]. Sometimes to give a fair picture of financialstatements losses are also shown as assets which makes the statements misleading. Assets less
depreciationshould be shown in balance sheet to give the real picture of the financial statementswhich can be useful for various interested parties. Assets include both current and fixed assetswhich are included in balance sheet in the preparation of financial statements[ CITATION Gib12 \l1033 ].The equity of the entityis a helpful concept which exists only in the minds of users. It meansequity capital actually does not provide a helping hand as interest is paid to investors forproviding the money and if profit is there then it is also distributed on per share basis. Whenentity is started capital is required which is provided by investors in the form of equity capitalwhich is considered a great help but it exist only in minds as payment is made for that moneygiven by investors in the form of equity capital.Costs are not assets. Cost refers to monetary value of expenditurefor raw material, equipment,supplies, services, labor and products etc. It is recorded as an expense in book- keeping. It is theamounts which are spent on the purchase of an asset along with amount spend on its installationand making it ready to use. Cost is not assets it is the amount which is spent on purchase of it.Asset is recorded on asset side of balance sheet and cost is recorded as an expense in incomestatement. Cost refers to amount spend on daily operations of business.Financial reports should not be prepared just to follow the ritual.It should provide a clearpicture about the company’s financial and profit position as it is on the basis of these reportsmany decisions are taken. If reports are faulty it can be harmful to business as well as investorsas they will not be able to take decisions correctly. All rules related to preparation of financialstatements should be followed to avoid confusion and to ascertain true value of business.Itshould be able to provide clear and meaningful information to various interested parties so thatdecisions are taken correctly.Users of financial statementsinclude investors, public, banks, government, customers,suppliers, managers and owners. Users of financial statements take decisions on the basis ofthese statements and if the statements are faulty they should not accept it. They should not beforced to tolerate the incorrect reports[ CITATION Ann183 \l 1033 ].As these re the basis ofdecisions and if they provide false or incorrect information then decisions may prove wrong andcan hinder the interest of parties involved. So if they are not providing correct information then itshould not be accepted by the parties involved and corrective measures should be imitated.Financial reporters should not do anythingfor which they are not authorized. They shouldonly perform task for which they are authorized. They should not be forced to prepare financialstatements in a manner that it gives positive reports which actually is not. They should discloseeverything that is important for business and interested parties whether it is positive or negative.They should not conceal any information which can have negative impact on business but isimportant to be known to various parties. Thus financial reporter should provide fair and truevalue of business by preparing statement the way it should be prepared.