Question

Explain why the financial statements are much more than simply accounting and numbers. Your assessment should include a discussion of each of the financial statements, what each statement represents, and its importance. In addition, you will discuss the different financial ratio categories, what they tell us, along with why the statements and ratios are important to managers, creditors, and investor

Answer 1

Financial statements are more than just a representation of the accounting number. It represents the financial situation of the company as to how is the company doing in terms of its sales, net profit, market share and others. It tells you how efficiently the company is using its asset to generate revenue for the shareholders of the company. There are basically three types of financial statement, statement of income and expenditure, statement of cash flow and balance sheet. Income statement shows the income for the accounting period as to what were the sources of the income and what were the sources for the expenditure. Cash flow statement shows the movement of cash inflow as well as outflow with from the company. It shows how much cash the company is able to generate and how it is using that. Balance sheet provides a snapshot of the total asset and liabilities at a certain point of time for the corporation. Different types of financial users have different requirements. The shareholders are more concerned with as to how much the company is generating return to them so they are more concerned with profitability ratios. Suppliers are more concerned with as to the company has enough liquidity in the short-term so that it is able to pay for the raw materials. Creditors are more concerned with the level of leverage and whether the company will be able to repay the debt back so they are more concerned with leverage ratio and interest coverage ratio. There are broadly four types of ratios.

· Liquidity ratios: These ratios measure a firm ability to pay back its short-term debt like paying to suppliers and meeting its working capital requirement. Current ratio is simply current asset divided by current liability and measure as to how much times current asset is in terms of current liabilities. Quick ratio improves on the current ratio by removing the inventory and prepaid assets.

· Leverage ratio: Leverage ratio is a measure as to how much debt the company is carrying as a component of total asset. High leverage means the company is riskier. There are basically two main leverage ratio, total debt ratio which is calculated as total debt divided by total asset and debt to equity ratio which is calculated as long-term debt divided by equity.

· Efficiency ratio: Efficiency ratio is a measure of as to how efficiently the company is using its asset to generate return for the company shareholders. There are many types of efficiency ratios like asset turnover ratio, inventory turnover ratio, receivable turnover ratio, payable turnover ratio. Asset turnover ratio is calculated as sales divided by total asset, it measures how much is sales as a number of times of total asset. Inventory turnover ratio measures how many times the inventory is sold.

· Profitability ratios: Profitability ratio is a measure of how much profit the company has been able to generate. There are many types of profitability ratios like net profit margin, return on equity, return on asset etc. Net profit margin measures as to how much net profit is as percentage of sales. Return on equity measures as to how much return has been generated for the shareholders of the company.