Lecture No.

Introduction:
Financial reporting is the method a firm uses to convey its financial performance to
the market, its investors, and other stakeholders.
The objective of financial reporting is to provide information on the changes in a
firm's performance and financial position that can be used to make financial and
operating decisions.
In addition to be a management aid, this information is used by analysts to forecast
the firm's ability to produce future earnings and as a means to assess the firm's
intrinsic value.
Other stakeholders, such as creditors, will use financial statements to evaluate the
company's economic and competitive strength.
Note: The timing and the methodology used to record revenues and expenses may
also impact the analysis and comparability of financial statements across companies.

Financial statements are prepared in most cases based on three basic premises:

The company will continue to operate (going-concern assumptions).

Revenues are reported as they are earned within the specified accounting period
(revenues-recognition principle).
Expenses should match generated revenues within the specified accounting period
(matching principle)

Financial statements are prepared using one of two basic accounting methods:

1. Cash-basis accounting - This method consists of recognizing revenue (income) and

expenses when payments are made (when checks are issued) or when cash is received
(and deposited in the bank).
2. Accrual accounting (Credit based) - This method consists of recognizing revenue in the
accounting period in which it is earned, that is, when the company provides a product or
service to a customer, regardless of when the company gets paid. Expenses are recorded
when they are incurred instead of when they are paid for.
Difference between Accounting and Finance

Finance and Accounting are two separate disciples that often are lumped together (as we
obviously have done). At a high level, Finance is the science of planning the distribution of a
business' assets. Accounting is the art of the recording and reporting financial transactions.
Accounting information provide basis to finance manager in future decision making;
financial decisions are derived from the accounting information of current periods.

Accounting Finance
Definition Preparation of accounting records Finance, on the other hand, is
i.e. Recording or Book keeping the efficient and productive
management of assets and
liabilities based on existing
information.
Purpose Measuring, preparation, analyzing, Decision making regarding
and interpretation of financial working capital issues such as
statements. To collect and present level of inventory, cash
financial information holding, credit levels,
financial strategy, managing
and controlling cash flow.
Goal To see how the company is To forecast the future
performing, to monitor day to day performance of the business.
accounting operations, and for
taxing.
Tools Balance sheets, profit and loss Performance reports, ratio
ledgers, positional declarations etc. analysis, risk analysis,
estimating break evens,
returns on investment,
statement of change in equity
etc.
Determination Revenue is acknowledged at the Revenues are acknowledged
of funds point of sale and not when it was during the actual receipt in
collected. Expenses are cash as in cash flow and the
acknowledged when they are expenses are acknowledged
incurred than when they are paid when the actual payment is
made as in cash outflow.
Accrual- Accounting Finance- Cash Basis (Accounting)
Sales 100,000 80,000 costs although incurred, but cash was
CGS 80,000 not collected.
Gross Profit 20,000 Cash Flow system: Sales: 100,000
Cash Receivables 70,000 Cash inflow 30,000
Payables 15,000 Cash outflow 80,000
Are we able to pay the payables? net (50,000)
No, our liquidity position is weak as per cash flow based accounting, and we cannot pay the
Accounts payables; which shows the weak liquidity position, which on other hand i.e.
Accrual based accounting: shows a strong position in books.
Bottom line: Finance manager should maintain the liquidity position; and based on
accounting information, we cannot judge the liquidity position.
Profitability VS Liquidity:
Profitability and liquidity are the two terms which are most widely watched by both the
investors and owners to gauge whether the business is doing good or not. Given below are the
differences between profitability and liquidity
Profitability Liquidity
Profitability refers to profits which the liquidity refers to availability of cash with the
company has made during the year which is company at any point of time.
calculated as difference between revenue and
expense done by the company
A profitable company may not have enough a company which has lot of cash or liquidity
liquidity because most of the funds of the may not be profitable because of lack of
company are invested into projects opportunities for putting idle cash.
Gross profit, net profit, operating profit, while current ratio, liquid ratio and cash debt
return on capital employed are some of the coverage ratio are some of the ratios which
ratios which are used to calculate profitability are used to calculate liquidity of the firm.
of the firm
A company which is profitable can go whereas a company which has liquidity but is
bankrupt in the short term if it does not have not profitable cannot go bankrupt in the short
liquidity term.
Time
Profitability is more important in long-term Liquidity is less important in short-term.
Ratios
Key ratios include GP margin, OP margin, Key ratios are current ratio and quick ratio
NP margin and ROCE
Profitability and liquidity are the most prominent issues that management of each
organization should take studying and thinking about them into account as their most
important duties. Liquidity refers to the ability of a firm to meet its short-term obligations.
Liquidity plays a crucial role in the successful functioning of a business firm. A weak
liquidity position poses a threat to the solvency as well as profitability of a firm and makes it
unsafe and unsound. Profitability is a measure of the amount by which a firms revenues
exceeds its relevant expenses. Potential investors are interested in dividends and appreciation
in market price of stock, so they pay more attention on the profitability ratios. Managers on
the other hand are interested in measuring the operating performance in terms of profitability.
Hence, a low profit margin would suggest ineffective management and investors would be
hesitant to invest in the company