7 Functions of financial management:
Financial planning
Forecasting
Organization function
Regulation
Coordination
Stimulation
Control
36. Corporate financial statements: purpose, types, users. Financial statements analysis.
Why do companies provide financial accounting statements? They have a variety of stakeholders: shareholders, bondholders, bankers, creditors, suppliers, employees and management, for example. All these stakeholders are interested in monitoring how well their interests are being served in the given company.
The balance sheet is a summary of the assets, liabilities, and equity of a business at a particular point in time - usually the end of the firm’s fiscal year. The balance sheet is also known as the statement of financial condition or the statement of financial position. The values shown for the different accounts on the balance sheet are not meant to reflect current market values; rather, they reflect historical costs.
Assets are the resources of the business enterprise, such as plant and equipment that are used to generate future benefits. If a company owns plant and equipment that will be used to produce goods for sale in the future, the company can expect these assets (the plant and equipment) to generate cash inflows in the future.
Liabilities are obligations of the business. They represent commitments to creditors in the form of future cash outflows. When a firm borrows, say, by issuing a long-term bond, it becomes obligated to pay interest and principal on this bond as promised.
Equity, also called shareholders’ equity or stockholders’ equity, reflects ownership. The equity of a firm represents the part of its value that is not owed to creditors and therefore is left over for the owners. In the most basic accounting terms, equity is the difference between what the firm owns—its assets—and what it owes its creditors—its liabilities.
An income statement is a summary of the revenues and expenses of a business over a period of time, usually either one month, three months, or one year. This statement is also referred to as the profit and loss statement. It shows the results of the firm’s operating and financing decisions during that time.
The operating decisions of the company - those that apply to production and marketing - generate sales or revenues and incur the cost of goods sold (also referred to as the cost of sales or the cost of products sold). The difference between sales and cost of goods sold is gross profit. Operating decisions also result in administrative and general expenses, such as advertising fees and office salaries. Deducting these expenses from gross profit leaves operating profit, which is also referred to as earnings before interest and taxes (EBIT), operating income, or operating earnings. When interest expenses and taxes, which are both influenced by financing decisions, are subtracted from EBIT, the result is net income. Net income is, in a sense, the amount available to owners of the firm. If the firm has preferred stock, the preferred stock dividends are deducted from net income to arrive at earnings available to common shareholders. If the firm does not have preferred stock, net income is equivalent to earnings available for common shareholders.
The statement of cash flows is a summary over a period of time of a firm’s cash flows from operating, investment, and financing activities.
The firm’s statement of cash flows lists separately its operating cash flows, investing cash flows, and financing cash flows. By analyzing these individual flows, current and potential owners and creditors can examine such aspects of the business as:
The source of financing for business operations, whether through internally generated funds or external sources of funds.
The ability of the company to meet debt obligations (interest and principal payments).
The ability of the company to finance expansion through operating cash flow.
The ability of the company to pay dividends to shareholders.
The flexibility the business has in financing its operations.
Additional information about equity can be found in the statement of shareholders’ equity, which is a breakdown of the amounts and changes in equity accounts. This statement serves as a connecting link between the balance sheet and the income statement, providing the analyst with more detail on changes in the individual equity accounts.
To analyze financial statements analysts use financial ratios. Ratio is the mathematical relation between two quantities. A financial ratio is a comparison between one bit of financial information and another.
In general all possible ratios can be classified according to how they are constructed or according to the financial characteristic that they capture.
There exist four possible ways to construct a ratio:
As a coverage ratio. A coverage ratio expresses firm’s ability to “cover” or meet a particular financial obligation. Any obligation of the firm may act as a denominator in the given kind of ratios while the amount of funds available to satisfy the given obligation expresses the numerator.
As a return ratio. The given ratio indicates the net benefit received by a firm from a particular investment of resources. The net benefit in general is what is left over after expenses, such as operating earnings or net income while total assets, fixed assets, inventory or any other investment may be the resources. Dividing the benefit by invested resources return ratio of the given investment is calculated.
As a turnover ratio. This ratio is a measure of how much a firm gets out of its assets. Comparing to the return ratio in the case of calculating the turnover ratio the gross benefit form an activity or investment is used as the numerator while the resources act as the denominator.
As a component percentage. A component percentage is the ratio of one amount in a financial statement, such as wages and salaries, to the total of amounts in that financial statement, such as total operating expenses.
According to the financial characteristic a particular ratio carries, they can be classified in the following way:
Coefficient of liquidity |
Coefficients of financial stability Analysis of a Company's Use of Debt |
Operating efficiency ratios |
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Current liquidity ratio: Current assets / Current liabilities |
1. Equity ratio Owner's Equity / Total Assets |
1. Total asset turnover Net Sales / Average Total Assets
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Quick liquidity ratio: (Cash & Cash equivalents + S.T. Investments + Accounts receivable) / Currents liabilities |
2. Debt ratio Total Debt/ Total Assets |
2. Fixed-Asset Turnover Net Sales / Average Fixed Assets |
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Critical liquidity ratio: Cash + S.T. Investments / Current liabilities |
3. Financial leverage ratio Total debt/ Shareholders equity |
3.Equity Turnover Net Sales / Average Total Equity |
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Return on investment ratios |
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1. Return on Assets (ROA) |
EBIT / Average Total Assets |
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2. Return on Total Equity (ROE) |
Net Income / Average Total Equity |
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Operating profitability ratios |
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1. Gross profit margin |
Gross Profit / Net Sales |
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2. Operating Profit Margin |
Operating Income / Net Sales |
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5. Net Margin (Profit Margin) |
Net Income / Sales |
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