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Information from financial statements

Q.4 EXPLAIN WHAT INFORMATION DOES EACH FINANCIAL STATEMENT


PROVIDE?
Ans:
1. INFORMATION FROM INCOME STATEMENT

The Income Statement is a direct result of the information that is recorded in the
journals and ledgers, and then transformed into concise, compiled revenue and
expense figures. It is usually prepared directly from the monthly “closing of the books”
and provides an accurate picture of the revenue and expense of the business for a
specified period of time; usually a month, quarter or year. The Income statement is used
by management within the company, but also by investors and creditors outside the
company to evaluate profitability, performance and aid in the assessment of risk for the
investor or creditor.

The Income Statement is divided into three parts: Total revenues, total expenses,
and net income. The first section listed on the Income Statement is the Total Revenues
reported for the particular period of time reported. Other than revenues generated from
the normal operations of business, there are other sources of revenue that must also be
included in the “Total Revenue” area. Rent and Interest Revenue would be included at
this point. Next, you have the section known as “Total Expenses”. This section includes
all expenses incurred in the direct operation of the business. The most common forms of
expense include wages, salaries, rents, utilities, insurance and supplies. Almost every
business has an inclusion of variable expenses that is lumped into one category known as
“miscellaneous expense”; these expenses are generally listed from largest to smallest,
with miscellaneous always being the last expense reported, no matter how large or small.
Finally, the entry known as “Net Income” is a result of the subtraction of the total
expenses from the total revenues.

The Net Income that is reported on the Income Statement is then transferred to the
Statement of Owner’s Equity, and incorporated further into the information that is made
available through the Financial Statements.

2. INFORMATION FROM BALANCE SHEET

The Balance Sheet for accounting is an extremely important and often used statement of
entity condition. It shows the extent of entity ownership of assets, liability and equity at a
given point in time. This point is the date on the statement. It is a physical representation
of the 'accounting equation.' The equation states that at any point in time, the assets of the
business are equal to the sum of the liabilities and owner's equity. The equation also
forms the basis of the statement structure, which mirrors the three aspects of the equation.
The three parts are: 1) assets, 2) liabilities and 3) owner's equity. Let's look at each one.

Assets are anything that the business owns. We tend to consider assets to be land,
buildings, vehicles, inventory and cash but they are also other things. The adding

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Information from financial statements

machines, computers, copyrights, patents, goodwill, time clocks, pens, wrenches, ladders,
paper and copy machines are also included. This expands the definition to encompass all
that the business has acquired by purchase or by owner contributions.

Liabilities - when doing accounting - on the other hand, are claims against the assets
excluding the owner's equity contributions. These claims can take several forms. Some
are both short- and long-term loans, bills for utilities, rent, employee expenses, bonds,
taxes and many other items. They reduce the total value of the assets. Interestingly,
liabilities are very liquid. They change on a constant basis. For instance, widgets are
purchased to sell, the business uses utilities to operate and cash or credit is needed to pay
these outside demands.

Finally, there is the Owner's Equity section of the Balance Sheet. This summarizes, in
varying degrees of detail, who owns the business. For instance, if stock is issued, it will
show what the stock is valued at and usually how many shares are outstanding. It is not
unusual to see differing issues of stock and wide differences in the values. In simple
businesses, the equity might just be divided between several partners. Though, the
Balance Sheet probably won't reveal the names of the partners and how much of the
business each one owns. The ownership is usually specified in other documents related to
the corporate records. But, this section will show an aggregate of the amounts.

The other important parts of the Owner's Equity, in accounting, are related to the Income
Statement. The Net Income, or Net Loss, is part of the equity portion. Typically there are
two parts to it representing the previous retained earnings of the entity and another part,
which represents present earnings. Together, they show how much the value of the
business has increased, or decreased because of entity operations. If the business is
operating at a loss, the Owner's Equity is becoming less valuable and will show that the
owners now have less equity that they had previously. If loss condition continues, the
business eventually ceases.

The Balance Sheet is an extremely important statement in the accounting and will be
found, sometimes several ways, in the company prospectus. It is also provided to various
government regulatory agencies. They use them to assure the business is complying with
laws, regulations and taxing requirements. Typically, there is an outside audit of this
statement along with the Income and Cash Flow statements too. This provides an outside
review and an opinion of how well the business is keeping their books. So, the Balance
Sheet is an extremely important financial document.

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Information from financial statements

3. INFORMATION FROM STATEMENT OF CASH FLOW

Cash flow refers to the movement of cash into and out of a business. Watching the cash
inflows and outflows is one of the most pressing management tasks for any business. The
outflow of cash includes those checks you write each month to pay salaries, suppliers,
and creditors. The inflow includes the cash you receive from customers, lenders, and
investors.
Positive Cash Flow
If its cash inflow exceeds the outflow, a company has a positive cash flow. A positive
cash flow is a good sign of financial health, but is by no means the only one.
Negative Cash Flow
If its cash outflow exceeds the inflow, a company has a negative cash flow. Reasons for
negative cash flow include too much or obsolete inventory and poor collections on
accounts receivable (what your customers owe you). If the company can't borrow
additional cash at this point, it may be in serious trouble.

The STATEMENT OF CASH FLOWS reports cash receipts and disbursement


related to the firm’s major activities:

o OPERATIONS - Cash transactions associated with running the


business.
o INVESTMENTS - Cash used in or provided by the firm’s investment
activities.
o FINANCING - Cash raised from the issuance of new debt or equity
capital or cash used to pay business expenses, past debts, or
company dividends.
• Accountants analyze all of the cash changes that have occurred from
operating, investing, and financing and determine the firm’s net cash
position.
• The CASH FLOW ANSWERS QUESTIONS such as:
o How much cash came into the business from current operations?
o Was cash used to buy stocks, bonds, or other investments?
o Were some investments sold that brought in cash?
o How much money came in from issues stock?
• Good Cash Flow Management
Good cash management is simple. It involves:
1. Knowing when, where, and how your cash needs will occur
2. Knowing the best sources for meeting additional cash needs
3. Being prepared to meet these needs when they occur, by keeping good
relationships with bankers and other creditors
The starting point for good cash flow management is developing a cash flow projection.
Smart business owners know how to develop both short-term (weekly, monthly) cash
flow projections to help them manage daily cash, and long-term (annual, 3-5 year) cash
flow projections to help them develop the necessary capital strategy to meet their
business needs.

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