Question

Describe and summarize the key financial statements used in a business organization. Explain three to five key financial ratios used to analyze a company.

Answer 1

Q1) Describe and summarize the key financial statements used in a business organization.

Ans) Key financial statements used in a business organization are as follows:

1. Balance Sheets

A balance sheet provides detailed information about a company’s assets, liabilities and shareholders’ equity.

• Assets: Something a business owns or controls (e.g. cash, inventory, plant and machinery, etc)
• Liabilities: Something a business owes to someone (e.g. creditors, bank loans, etc)
• Equity: What the business owes to its owners. This represents the amount of capital that remains in the business after its assets are used to pay off its outstanding liabilities. Equity therefore represents the difference between the assets and liabilities

2. Income Statement

Income Statement, also known as the Profit and Loss Statement, reports the company's financial performance in terms of net profit or loss over a specified period. Income Statement is composed of the following two elements:

• Income: What the business has earned over a period (e.g. sales revenue, dividend income, etc)
• Expense: The cost incurred by the business over a period (e.g. salaries and wages, depreciation, rental charges, etc)

Net profit or loss is arrived by deducting expenses from income.

3. Cash Flow Statement

Cash Flow Statement, presents the movement in cash and bank balances over a period. The movement in cash flows is classified into the following segments:

• Operating Activities: Represents the cash flow from primary activities of a business.
• Investing Activities: Represents cash flow from the purchase and sale of assets other than inventories (e.g. purchase of a factory plant)
• Financing Activities: Represents cash flow generated or spent on raising and repaying share capital and debt together with the payments of interest and dividends

4. Statement of Changes in Equity

Statement of Changes in Equity, also known as the Statement of Retained Earnings, details the movement in owners' equity over a period. The movement in owners' equity is derived from the following components:

• Net Profit or loss during the period as reported in the income statement
• Share capital issued or repaid during the period
• Dividend payments
• Gains or losses recognized directly in equity (e.g. revaluation surpluses)
• Effects of a change in accounting policy or correction of accounting error

Q2) Explain three to five key financial ratios used to analyze a company.

Ans) Five key financial ratios used to analyze a company are as follows:

1. Working Capital Ratio

Assessing the health of a company in which you want to invest involves understanding its liquidity—how easily that company can turn assets into cash to pay short-term obligations. The working capital ratio is calculated by dividing current assets by current liabilities.

2. Quick Ratio

Also called the acid test, this ratio subtracts inventories from current assets, before dividing that figure into liabilities. The idea is to show how well current liabilities are covered by cash and by items with a ready cash value. Inventory, on the other hand, takes time to sell and convert into liquid assets.

3. Earnings per Share

When buying a stock, you participate in the future earnings (or risk of loss) of the company. Earnings per share (EPS) measures net income earned on each share of a company's common stock. The company's analysts divide its net income by the weighted average number of common shares outstanding during the year

4. Price-Earnings Ratio
The price-to-earnings, or P/E, ratio shows how much stock investors are paying for each rupee of earnings. It shows if the market is overvaluing or undervaluing the company. You determine the share price of the company's stock and divide it by EPS to obtain the P/E ratio.

5. Debt-Equity Ratio

The debt-to-equity is calculated by adding outstanding long and short-term debt, and dividing it by the book value of shareholders equitythe book value of shareholders' equity.the book value of shareholders' equity.