Tag: Financial

  • Financial Statements Analysis and Explanation of Accounting

    Financial Statements Analysis and Explanation of Accounting

    Financial Statements Analysis and Explanation; What is Analysis? An analysis is a process of breaking a complex topic or substance into smaller parts to gain a better understanding of it. Financial statements are prepared primarily for decision making. The statements are not an end in themselves but are useful in decision making. Financial analysis is the process of determining the significant operating and financial characteristics of a firm from accounting data. The profit and Loss Account and Balance Sheet are indicators of two significant factors-Profitability and Financial Soundness. Analysis of statement means such a treatment of the information contained in the two statements as to afford a full diagnosis of the profitability and financial position of the firm concerned.

    The concept of Cost Accounting explains Analysis and their Explanation of Financial Statements.

    Financial statement analysis is largely a study of the relationship among the various financial factors in a business as disclosed by a single set of statements and a study of the trends of these factors as shown in a series of statements. This post we will discuss the analysis and interpretation of financial statements of a company.

    The main function of financial analysis is the pinpointing of the strength and weaknesses of a business undertaking by regrouping and analysis of figures contained in the financial statements, by making comparisons of various components and by examining their content. The financial statements are the best media of documenting the results of managerial efforts to the owners of the business, its employees, its customers and the public at large, and thus become excellent tools of public relations. The following topic of the analysis and explanation of the financial statements is below are;

    Analysis of Financial Statements:

    Analysis includes:

    • Breaking financial statements into simpler ones.
    • Regrouping.
    • Rearranging the figures given in financial statements, and.
    • Finding out ratios and percentages.

    Thus all processes which help in drawing certain results from the financial statements are included in the analysis. The data provided in the financial statements should methodically classify and compare with figures of the previous period or other similar firms. Thereafter, the significance of the figures is establishing. The work of an accountant in analyzing financial statements is the same as that of a pathologist, who takes a drop of blood and analyses it to point out its various components and gives a report based on his analysis.

    Similarly:

    An accountant makes an analysis of each item appearing in financial statements and then reports based on his analysis. The analysis only establishes a relationship between various amounts mentioned in the Balance Sheet and Profit and Loss Account. After analyzing the financial statements, the next step is to use the mind for forming an opinion about the enterprise. This is the interpretation stage. The technique is called “Analysis and Interpretation” of financial statements.

    The analysis consists of breaking down a complex set of facts or figures into simple elements. Interpretation, on the other hand, consists of explaining the real significance of these simplified statements. Interpretation includes both analysis and criticism. To interpret means to put the meaning of statement into simple terms for the benefit of a person. Interpretation is to explain in such a simple language the financial position and earning capacity of the company which may understand even by a layman, who does not know to account. The analysis and interpretation of financial statements require a comprehensive and intelligent understanding of their nature and limitations as well as the determination of the monetary valuation of the items.

    The analyst must grasp what represent sound and unsound relationship reflected by the financial statements. Interpretation is impossible without analysis. “Interpretation is not possible without analysis and interpretation analysis has no value”. Analysis and interpretation act as a bridge between the art of recording and reporting financial information and the act of using this information. Analysis refers to the process of fact-finding and breaking down the complex set of figures into simple components while interpretation stands for explaining the real significance of these simplified components. Interpretation is a mental process based on analysis and criticism.

    Points:

    George O May points out the following uses of financial statements:

    • Report on stewardship.
    • The basis for fiscal policy.
    • Determine the legality of dividends.
    • A guide to advise dividend action.
    • The basis for granting of credit.
    • Informative for prospective investors in an enterprise.
    • The guide to the value of investment already made.
    • An aid to Government supervision.
    • The basis for price or rate regulation, and.
    • A basis for taxation.

    A financial analyst can adopt the following tools for analysis of the financial statements:

    • Comparative Financial Statements.
    • Common Size Statements.
    • Trend Ratios or Trend Analysis.
    • Statement of Changes in Working Capital.
    • Fund Flow and Cash Flow Analysis, and.
    • Ratio Analysis.

    Procedure for Interpretation:

    • Ascertain the purpose and the extent of analysis and interpretation.
    • Study the available data contained in financial statements.
    • Get additional information, if needed.
    • Arrange the data in a useful manner.
    • Prepare comparative statements, ratios, etc.
    • Interpret the facts revealed by the analysis.
    • The interpretation drawn from the analysis is presented.
    Objectives of Analysis and Interpretation:

    The following are the main objectives of analysis and interpretation of financial statements:

    • To estimate the earning capacity of the firm.
    • To assess the financial position of the firm.
    • Decide about the prospects of the firm.
    • To know the progress of the firm.
    • To judge the solvency of the firm.
    • Measure the efficiency of operations.
    • Determine the debt capacity of the firm.
    • To assess the financial performance of the firm.
    • To have a comparative study.
    • Help in making plans.

    Analysis of financial statements should always tune to the objective. People use financial statements for satisfying their particular curiosity. Financial accounts are interpreted by different persons in different ways according to their objects. For instance, the same financial statement may be very good for one; ordinarily good for the other and worst for the third. This is because of their views and objects of interpretation differ.

    For instances:
    • A prospective shareholder would like to know whether the business is profitable and is progressing on sound lines.
    • A supplier who would like to transact business with the firms may interest in the company’s ability to honor its short-term commitments.
    • A financier would like to satisfy the safety and reliability of the return on his investment. Thus, the object of the analysis determines the extent, depth, and nature of the analysis.

    Financial Statement Analysis:

    Financial performance, as a part of financial management, is the main indicator of the success or failure of the companies. The performance analysis can consider as the heart of the financial decisions. Also, Rational evaluation of the performance of the companies is essential to prepare sound financial policies and to attract potential investors. Shareholders are interested in EPS, dividend, net worth and market value per share. Management is interested in all aspects of financial performance to adopt a good financial management system and for the internal control of the company.

    The creditors are primarily interested in the liquidity of the company. The government is interested in the regulatory point of view. Besides, other stakeholders such as economists, trade associations, competitors, etc are also interested in the financial performance of the company. Therefore, all the stakeholders are interested in the performance of the companies but their perspective may be different. Financial statement analysis helps to highlight the financial performance of the company. It is the process of identifying the financial strength and weakness of a firm by properly establishing the relationship between the items on the Balance Sheet and those on the Profit and Loss Account.

    Extra Notes:

    It is a general term referring to the process of extracting and studying information in financial statements for use in management decision making, for example, financial statement analysis typically involves the use of ratios, comparison with prior periods and budget, and other such procedures. The financial appraisal is a scientific evaluation of the profitability and strength of any business concerns.

    It seeks to spotlight the significant impacts and relationships concerning managerial performance, corporate efficiency, financial strength and weakness and creditworthiness of the company. The objective of financial statement analysis is a detailed cause and effect study of the profitability and financial position. Also, Financial Analysis is the process of determining the significant operating and financial characteristics of a firm from accounting data and financial statements.

    The goal of such analysis is to determine the efficiency and performance of the firm’s management, as reflected in the financial records and reports. Financial statements are such records and reports, which contain the data required for performance management. As well as, it is therefore important to analyze the financial statements to identify the strengths and weaknesses of the company.

    Financial Statements Analysis and Explanation of Accounting
    Financial Statements Analysis and Explanation of Accounting, Image credit from #Pixabay.
  • Objectives, Techniques, and Types of Financial Statement Analysis

    Objectives, Techniques, and Types of Financial Statement Analysis

    Types of Financial Statement Analysis; The financial statement of a business enterprise is intending to provide much of the basic data used for decision making, and in general, evaluation of performance by various groups such as current owners, potential investors, creditors, government agencies, and in some instance, competitors. Financial statements are the reports in which the accountant summarizes and communicates the basic financial data. The creditors are primarily interested in the liquidity of the company. The government interests in the regulatory point of view. Besides, other stakeholders such as economists, trade associations, competitors, etc are also interested in the financial performance of the company. So, what we discussing is – Objectives, Techniques, and Types of Financial Statement Analysis.

    Cost Accounting explains the Objectives, Techniques, and Types of Financial Statement Analysis.

    In this article what discuss: Basic Objectives of Financial Statement Analysis, Main Objectives of Financial Statement Analysis, then Techniques of Financial Statement Analysis, and finally discussing the Types of Financial Statement Analysis. The following content is below: Financial statement analysis helps to highlight the financial performance of the company. It is the process of identifying the financial strength and weakness of a firm by properly establishing the relationship between the items on the Balance Sheet and those on the Profit and Loss Account.

    Objectives and Importance of Financial Statement Analysis:

    The primary objective of financial statement analysis is to understand and diagnose the information contained in the financial statement to judge the profitability and financial soundness of the firm and to make the forecast about the prospects of the firm. The purpose of analysis depends upon the person interested in such an analysis and his object.

    However, the following purposes or objectives of financial statements analysis may state to bring out the significance of such analysis:

    • To assess the earning capacity or profitability of the firm.
    • To assess the operational efficiency and managerial effectiveness.
    • Assess the short term as well as long-term solvency position of the firm.
    • To identify the reasons for the change in profitability and financial position of the firm.
    • Make the inter-firm comparison.
    • Make forecasts about the prospects of the firm.
    • To assess the progress of the firm over some time.
    • Help in decision making and control.
    • Guide or determine the dividend action, and.
    • Provide important information for granting credit.

    Basic Objectives of Analysis and Explains:

    The users of financial statements have definite objectives to analyze and interpret. Therefore, there are variations in the objectives of interpretation by various classes of people.

    However, there are certain specific and common objectives which are listed below:

    • To interpret the profitability and efficiency of various business activities with the help of a profit and loss account.
    • Measure the managerial efficiency of the firm.
    • Measure the short-term and long-term solvency of the business.
    • Ascertain earning capacity in the future period.
    • Determine the future potential of the concern.
    • Measure the utilization of various assets during the period, and.
    • Compare the operational efficiency of similar concerns engaged in the same industry.

    Main Objectives of Financial Statement Analysis:

    The major objectives of financial statement analysis are to provide decision-makers with information about a business enterprise for use in decision-making. Users of financial statement information are the decision-makers concerned with evaluating the economic situation of the firm and predicting its future course.

    Financial statement analysis can use by different users and decision-makers to achieve the following objectives:

    Assessment of Past Performance and Current Position:

    Past performance is often a good indicator of future performance. Therefore, an investor or creditor is interested in the trend of past sales, expenses, net income, cash flow and return on investment. These trends offer a means for judging management’s past performance and are possible indicators of future performance.

    Similarly, the analysis of the current position indicates where the business stands today. For instance, the current position analysis will show the types of assets owned by a business enterprise and the different liabilities due to the enterprise. It will tell what the cash position is, how much debt the company has about equity and how reasonable the inventories and receivables are.

    Prediction of Net Income and Growth Prospects:

    The financial statement analysis helps in predicting the earning prospects and growth rates in the earnings which are using by investors while comparing investment alternatives and other users interested in judging the earning potential of business enterprises.

    Investors also consider the risk or uncertainty associated with the expected return. The decision-makers are futuristic and always concerned with the future. Financial statements that contain information on past performances are analyzing and interpret as a basis for forecasting future rates of return and for assessing risk.

    Prediction of Bankruptcy and Failure:

    Financial statement analysis is a significant tool in predicting the bankruptcy and failure probability of business enterprises. After being aware of probable failure, both managers and investors can take preventive measures to avoid/ minimize losses. Corporate management can effect changes in operating policy, reorganize financial structure or even go for voluntary liquidation to shorten the length of time losses.

    In the accounting and finance area, empirical studies conducted have suggested a set of financial ratios that can give an early signal of corporate failure. Such a prediction model based on financial statement analysis is useful for managers, investors, and creditors. Managers may use the ratios prediction model to assess the solvency position of their firms and thus can take appropriate corrective actions.

    Investors and shareholders can use the model to make the optimum portfolio selection and to bring changes in the investment strategy by their investment goals. Similarly, creditors can apply the prediction model while evaluating the creditworthiness of business enterprises.

    Loan Decision by Financial Institutions and Banks:

    Financial statement analysis uses by financial institutions, loaning agencies, banks, and others to make a sound loan or credit decision. In this way, they can make the proper allocation of credit among the different borrowers. Financial statement analysis helps in determining credit risk, deciding the terms and conditions of the loan if sanctioned, interest rate, maturity date, etc.

    Techniques of Financial Statement Analysis:

    Various techniques are using in the analysis of financial data to emphasize the comparative and relative importance of data presented and to evaluate the position of the firm.

    Among the more widespread use of these techniques are the following:

    • Horizontal Analysis.
    • Vertical Analysis.
    • Trend Analysis.
    • Ratio Analysis.
    • Cash flow analysis.
    • Funds flow analysis.
    • Comparative financial statements.
    • Common measurement or size statements, and.
    • Net Working capital analysis.

    Now, explain each;

    Horizontal Analysis:

    The percentage analysis of increases and decreases in corresponding items in comparative financial statements calls horizontal analysis. The horizontal analysis involves the computation of amount changes and percentage changes from the previous to the current year.

    The amount of each item on the most recent statement compares with the corresponding item on one earlier statement. The increase or decrease in the amount of the item is then listed, together with the percent of increase or decrease. When the comparison makes between two statements, the earlier statement uses as the base.

    If the horizontal analysis includes three or more statements, there are two alternatives in the selection of the base. First, the earliest date or period may use as the basis for comparing all later dates or periods or second, each statement may compare with the immediately preceding statement.

    The percent change computes as follows:

    Percentage change = Amount of change/Previous year amount x 100.

    Vertical Analysis:

    The analysis uses percentages to show the relationship of the different parts to the total in a single statement. Vertical analysis sets a total figure in the statements equal to 100 percent and computes the percentage of each component of that figure. The figure to use as 100 percent will be total assets or total liabilities and equity capital in the case of the balance sheet and revenue or sales in the case of the profit and loss account.

    Trend Analysis:

    Using the previous year’s data of a business enterprise, trend analysis can finish observing percentage changes over time in selected data. In trend analysis, percentage changes are calculating for several successive years instead of between two years. Trend analysis is important because, with its long-run view, it may point to basic changes like the business.

    By looking at a trend in a particular ratio, one may find whether that ratio is falling, rising or remaining relatively constant. From this observation, a problem is detecting or the sign of good management is found. Trend analysis uses an index number over some time. For index number, one year, the base year is equal to 100 percent. Other years are measuring that amount. For example, an analyst may interest in sales and earnings trends for the past five years.

    For this purpose, the sales and earnings data of a company are given to prepare further the trend analysis or percentages. The above data show a fairly healthy growth pattern but the pattern of change from year to year can determine more precisely by calculating trend percentages. To do this, a base year selects and then the data are divided for each of the other years by the base year data.

    Ratio Analysis:

    Ratio analysis is an important means of expressing the relationship between two numbers. A ratio can compute from any pair of numbers. To be useful, a ratio must represent a meaningful relationship, but the use of ratios cannot take the place of studying the underlying data.

    Ratios are guides or shortcuts that are useful in evaluating the financial position and operations of a company and in comparing them to previous years or other companies. The primary purpose of ratios is to point out areas for further investigation. They should use in connection with a general understanding of the company and its environment. Comparison of income statement and balance sheet numbers, in the form of ratios, can create difficulties due to the timing of the financial statements.

    Specifically, the profit and loss account covers the entire fiscal period, whereas the balance sheet is for a single point in time, the end of the period. Ideally then, to compare an income statement figure such as sales to a balance sheet figure such as receivable, we usually need a reasonable measure of average receivables for the year that the sales figure covers.

    However, these data are not available to the external analyst. In some cases, the analyst should take the next best approach, by using an average of beginning and ending balance sheet figures. This approach smoothes out changes from beginning to end, but it does not eliminate the problem due to seasonal and cyclical changes. It also does not reflect changes that occur unevenly throughout the year.

    Cash flow Analysis:

    Cash flow analysis depicts the inflows and outflows of cash. The cash flow statement is the device for such an analysis. It highlights causes that bring changes in cash position between two balance sheet dates.

    Funds Flow Analysis:

    Funds flow statement signifies the sources and applications of funds. The term ‘funds’ refers to working capital. Funds flow analysis clearly shows internal and external sources of working capital and the way funds have been using. Funds flow derives from analysis of changes that have taken place in assets and equities between two balance sheet dates.

    According to Foulke,

    “A statement of sources and application of funds is a technical device design to analyze the changes in the financial position of a business concern between two periods.”

    Funds flow analysis helps judge creditworthiness, financial planning, and budget preparation.

    Comparative Financial Statements:

    This is yet another technique used in financial statement analysis. This is statements summarize and present related data for several years. Incorporating therein changes (absolute and relative) in individual items of financial statements.

    The statements normally comprise comparative balance sheets, comparative profit, and loss account. And, comparative statements of change in total capital as well as in the working capital. Also, these statements help in making inter-period and inter-firm comparisons and also highlight. The trends in performance efficiency and financial position.

    Common Size Statements:

    Common size statements indicate the relationship of various items with some common items, (expressed as a percentage of the common item). In the income statements, the sales figure takes as the basis and all other figures are expressing as a percentage of sales.

    Similarly, in the balance sheet, the total assets and liabilities are taking. As the base and all other figures are expressing as the percentage of this total. The percentages so calculate are comparing with corresponding percentages in other periods or other firms and meaningful conclusions are drawn. Generally, a common size income statement and common size balance sheet are preparing.

    Networking Capital Analysis:

    Networking capital statement or schedule of changes in working capital prepares to disclose net changes in working capital on two specific dates (generally two balance sheet dates). It is preparing from current assets and current liabilities on the specified dates to show a net increase or decrease in working capital.

    Types of Financial Statement Analysis:

    The process of financial statement analysis is of different types. The process of analysis is classifying based on information use and “Modus Operandi” of analysis.

    The classification is as under – (1) based on Information:

    External Analysis:

    This analysis is base on published the financial statements of a firm. Outsiders have limited access to internal records of the concern. Therefore, they depend on publishing financial statements. Thus, the analysis done by outsiders namely, creditors, suppliers, investors, and government agencies knows as external analysis. This analysis serves a very limited purpose.

    Internal Analysis:

    This analysis is done based on internal and unpublished records. It is done by executives or other authorized officials. It is very much useful and significant to employees and management.

    (2) Based on “Modus Operandi” of Analysis:

    Horizontal Analysis:

    This analysis is also known as ‘dynamic’ or ‘trend’ analysis. The analysis is done by analyzing the statements for several years. According to John N. Myer, “the horizontal analysis consists of a study of the behavior of each of the entities in the statement”. Thus, under horizontal analysis, we study the behavior of each item shown in the financial statements.

    We examine as to what has been the periodical trend of various items shown in the statements i.e., whether they have to increase or decrease over some time. If the comparative statements are preparing for more than two periods, then one of the years takes as a basis to calculate the percentage of increase or decrease. Some analysts prefer to choose the earliest year as the basis, while some others prefer to take just the preceding year as the basis.

    Vertical Analysis:

    The analysis also knows as ‘static analysis’ or ‘structural analysis’. This analysis makes based on a single set of financial statements preparing on a particular date. Under vertical analysis, the quantitative relationship is establishing between different items shown in particular statements. Common-size statements are a form of vertical analysis. Different items shown in the statement are expressing as a percentage to any one item as the base. The use of both methods of analysis is very much requiring for proper analysis. Each method provides a specific type of information and in fact, both methods constitute the backbone of financial analysis.

    Objectives Techniques and Types of Financial Statement Analysis
    Objectives, Techniques, and Types of Financial Statement Analysis. Image credit from #Pixabay.
  • Meaning, Process, Definition, Concept of Financial Statement Analysis

    Meaning, Process, Definition, Concept of Financial Statement Analysis

    What is Financial Statement Analysis? Financial statement analysis is the use of analytical or financial tools to examine and compare financial statements to make business decisions. Financial statement analysis helps to highlight the financial performance of the company. It is the process of identifying the financial strength and weakness of a firm by properly establishing the relationship between the items on the Balance Sheet and those on the Profit and Loss Account. So, what we discussing is – Meaning, Process, Definition, Concept of Financial Statement Analysis.

    Cost Accounting is explains Meaning, Process, Definition, Concept of Financial Statement Analysis.

    In this article, we will discuss the Meaning and Process of Financial Statement Analysis, Definition of Financial Statement Analysis, and Concept of Financial Statement Analysis.

    So be it discuss:

    It is a general term referring to the process of extracting and studying information in financial statements for use in management decision making, for example, financial statement analysis typically involves the use of ratios, comparison with prior periods and budget, and other such procedures.

    The financial appraisal is a scientific evaluation of the profitability and strength of any business concerns. It seeks to spotlight the significant impacts and relationships concerning managerial performance, corporate efficiency, financial strength and weakness and creditworthiness of the company.

    Meaning and Process of Financial Statement Analysis and their Interpretation:

    The nature and importance of financial statements are explained in the preceding pages. It has been explaining that facts disclosed by financial statements are of outstanding significance to the various parties interested in the financial position of a business concern. The financial statements are helpful to the executives to assess the implications of their decisions, evaluate and review their performance and implement corrective action.

    Financial statements render invaluable service to owners, employees, customers, suppliers and the government in their respective fields of interest. The financial statements are useful and meaningful only when they are analyzed and interpreted.

    The scientific method has to adapt to analyze and interpret these statements as done in the case of preparation of these statements. The effort is taken to understand the implications of the statements is called interpretation. Some people call it ‘examination’, ‘criticism’ or ‘analysis’. Therefore, it is meaningful to call it ‘analysis and interpretation’.

    Purpose:

    The purpose of the financial analysis is to diagnose the information contained in financial statements to judge the profitability and financial soundness of the firm. Just like a doctor examines his patient by recording his body temperature, blood pressure, etc. before making his conclusion regarding the illness and before giving his treatment, a financial analyst analysis the financial statements with various tools of analysis before commenting upon the financial health or weaknesses of an enterprise.

    Definition of Financial Statement Analysis:

    Wood in his work “Business Accounting” has defined the term interpretation as follows:

    “To interpret means to put the meaning of a statement in simple terms for the benefit of a person”.

    In the words of Myers,

    “Financial statement analysis is largely a study of the relationship among the various financial factors in a business as disclosed by a single set of the statement and a study of the trend of these factors as shown in a series of statements.”

    Kennedy and Muller said,

    “Analysis and interpretation of financial statements are an attempt to determine the significance and meaning of the financial statement data so that forecast may be made of the prospects for future earnings, ability to pay interest and debt maturities (both current and long-term) and the probability of a sound dividend policy.”

    The balance sheet and profit and loss account are to interpret to convey a meaningful message to the layman who is still the typical shareholder in our country.

    Interpretation considers being the most important function of a management accountant because the management of today needs relevant data and information to conduct its function efficiently. The information is more valuable if it is presenting in an analytical form than in absolute form.

    Management Accountant is expecting to analyze and interpret the financial statements to perform his basic duty of “Communication to the management”. Interpretation in its widest sense includes many processes like the arrangement, analysis, establishing a relationship between available facts and finally making conclusions.

    The Concept of Financial Statement Analysis:

    Financial performance, as a part of financial management, is the main indicator of the success or failure of the companies. Financial performance analysis can consider as the heart of the financial decisions. Rational evaluation of the performance of the companies is essential to prepare sound financial policies and to attract potential investors. Shareholders are like in EPS, dividend, net worth and market value per share.

    Management interests in all aspects of financial performance to adopt a good financial management system and for the internal control of the company. The creditors are primarily interested in the liquidity of the company. Government interests from the regulatory point of view. Besides, other stakeholders such as economists, trade associations, competitors, etc are also interested in the financial performance of the company.

    Therefore, all the stakeholders are like in the performance of the companies but their perspective may be different. The objective of financial statement analysis is a detailed cause and effect study of the profitability and financial position.

    Process:

    Financial Analysis is the process of determining the significant operating and financial characteristics of a firm from accounting data and financial statements. The goal of such analysis is to determine the efficiency and performance of the firm’s management, as reflected in the financial records and reports.

    Financial statements are such records and reports, which contain the data required for performance management. It is therefore important to analyze the financial statements to identify the strengths and weaknesses of the company.

    The financial statements of a business enterprise are intending to provide much of the basic data used for decision making, and in general, evaluation of performance by various groups such as current owners, potential investors, creditors, government agencies, and in some instances, competitors.

    Financial statements are the reports in which the accountant summarizes and communicates the basic financial data. The financial statements provide the summary of an account of the company- the Balance Sheet reflecting the assets, liabilities, and capital as of a certain date. And, the Profit and Loss Account showing the results of operation during a period.

    The financial statements are a collection of data organized according to logical and consistent accounting procedures. The function of the financial statement is to convey an understanding of some financial aspects of the company.

    Financial statement analysis:

    Financial statement analysis involves appraising the financial statement and related footnotes of an entity. This may finish by accountants, investment analysts, credit analysts, management and other interested parties. Financial statements indicate an appraisal of a company’s previous financial performance and its future potential. The analysis of a financial statement finishes obtaining better insight into a firm’s position and performance.

    Analyzing a financial statement is a process of evaluating the relationship between parts of the financial statement to obtain. A better understanding of the firm’s position and performance. The financial analysis is thus the analysis of the financial statements. Which is finish to evaluate the performance of the company?

    Types of analysis:

    Ratio Analysis, Trend Analysis, Comparative Financial Statement Analysis, and Common Size Statement Analysis are the major tools of the financial analysis. Financial statement analysis involves the computation of ratios to evaluate a company’s financial position and results of operation. A ratio is an important tool for financial statement analysis.

    The relationship between two accounting figures expressed mathematically knows as the financial ratio. The ratio used as an index of yardstick for evaluating the financial position and performance of the firm. It helps analysts to make a quantitative judgment about the financial position and performance of the firm. It uses financial reports and data and summarizes the key relationship to appraise financial performance.

    Ratio analysis:

    Ratio analysis is such a powerful tool for financial analysis. That through it, the economic and financial position of a business unit can be fully x-ray. Ratios are just a convenient way to summarize largely. Quantities of financial data and to compare the performance of the firms. Ratios are exceptionally useful tools with which one can judge. The financial performance of the firm over some time. Performance ratio can provide insight into a bank’s profitability, return on investment, capital adequacy and liquidity.

    The above theories suggest that financial analysis helps to measure the performance of the companies. Different analysts desire different types of ratios, depending largely on whom the analysts are and why the firm is evaluating. Short-term creditors are concerning with the firm’s ability to pay its bills promptly. In the short run, the amount of liquid assets determines the ability to pay off current liabilities.

    They are like liquidity. Long-term creditors hold bonds or debentures; mortgages against the firm are like in the current payment of interest and the eventual repayment of the principal. The company must be sufficiently liquid in the short-term and have adequate profits for the long-term. They examine liquidity and profitability.

    Stockholders, in addition to liquidity and profitability, are concerned about the policies of the firm’s stock. Without liquidity, the firm could not pay the cash dividends. Without profits, the firm could not be able to declare dividends. With poor policies, the common stock would trade at a lower price in the market. Analysis of the financial statement of a company for one year or a shorter period would not truly reflect the nature of its operations. For this, it is essential that the analysis reasonably cover a longer period.

    Trend Analysis:

    The analysis made over a longer period is termed as Trend Analysis. Trend Analysis of the ratio indicates the direction of change. This method involves the calculation of the percentage relationship that each item bears to the same item in the base year. The trend percentage discloses the changes in the financial and operating data between specific periods and makes. It is possible to form an opinion as to whether favorable and unfavorable tendencies are reflecting by the data.

    Comparative Statement Analysis is another method of measuring the performance of the company. It uses to compare the performance and position of the firm with the average performance of the industry or with other firms. Such a comparison will identify areas of weakness that can then address to rectify the situation.

    Meaning Process Definition Concept of Financial Statement Analysis
    Meaning, Process, Definition, Concept of Financial Statement Analysis. Image credit from #Pixabay.
  • 10 Key Financial Accounting Limitations help for Better Solution

    10 Key Financial Accounting Limitations help for Better Solution

    Financial Accounting Limitations: The financial statements reflect a combination of recorded facts, accounting conventions, and personal judgments of the preparers. Definition of Financial Accounting concerns with providing information to external users. It refers to the preparation of general-purpose reports for use by persons outside a Business Enterprise, such as Shareholders (existing and potential), Creditors, Financial analysts, Labor unions, Government authorities, and the like. So, what we were discussing: 10 Key Financial Accounting Limitations help for Better Solution.

    The Concept of Financial Accounting explains their Limitations are very helpful for Better Solution.

    Financial accounting is oriented towards the preparation of financial statements which summarise the results of operations for selected periods of time and show the financial position of the business at particular dates.

    Simple limitations also helpful:

    Financial accounting suffers from the following limitations which have been responsible for the emergence of cost and management accounting:

    • Does not provide detailed cost information for different departments, processes, products, jobs in the production divisions. Similarly, separate cost data are not available for different services and functions in the administration division. Management may need information about different products, sales territories, and sales activities which are also not available in financial accounting.
    • Recording and accounting for wages and labor does not carry out for different jobs, processes, products, departments. This creates problems in analyzing the cost associated with different activities. This also does not provide a basis for rewarding workers and employees for above-average performance.
    • Does not set up a proper system of controlling materials and supplies. Undoubtedly, if material and supplies are not controlled in a manufacturing concern, they will lead to losses on account of misappropriation, misutilization, scrap, defectives, etc. They may, in turn, influence the reported net income of a business enterprise.
    • It is difficult to know the behavior of costs in financial accounting as expenses do not assign to the product at each stage of production. Expenses are not classified into direct and indirect, and therefore, cannot classify as controllable and uncontrollable. Control of cost which is the most important objective of all business enterprises cannot achieve with the aid of financial accounting alone.
    Other limitations:
    • Does not possess an adequate system of standards to evaluate the performance of departments and employees working in the departments. Standardization now applies to all elements of the business. Standards need to develop for materials, labor, and overheads so that a firm can compare the work of laborers, workers, supervisors, and executives with what should have been done in an allotted period of time.
    • Does not provide information to analyze the losses due to various factors, such as idle plant and equipment, seasonal fluctuations in the volume of business, etc. It does not help management in taking important decisions about the expansion of business, dropping a product line, starting with a new product, alternative methods of production, improvement in product, etc. Managerial decisions about these business matters have now become vital for the survival and growth of business enterprises.
    • Contains historical cost information which accumulates at the end of the accounting period. This accounting does not provide day-to-day information about costs and expenses. This is the reason why much dissatisfaction has been shown with external financial reporting. Historical cost is not a reliable basis for predicting future earnings, solvency, or overall managerial effectiveness. Historical cost information is relevant but not adequate for all purposes. It is now rightly contended that current cost information should report along with historical cost information.

    Ten Key Financial Accounting Limitations:

    The following points highlight the ten limitations of financial accounting.

    They are: 

    Controlling Cost Impossible:

    In financial accounting control of cost is not possible since the costs are known at the end of the financial year or a specified period of time whether the expense or cost has already been incurred, i.e., nothing can be done to control either the account of expense or the cost. In other words, if it even finds that a particular cost is more, it is not possible to control it. But the same is possible only when the cost accounting system introduces.

    Recording Actual Cost:

    The financial accounting records the actual cost only, the historical cost of the assets. The value of assets may change, but record only the cost of acquisitions of such assets. In other words, financial accounting does not record the price fluctuations or changes in the price level. As a result, it does not present the correct information.

    Difficulty in Price Fixation:

    We know that the total cost of a product can obtain only when all expenses relating to a product have been incurred. That is why it is not possible to ascertain the price of the product in advance for the estimated selling price. As total cost (i.e., fixed, variable, direct, and indirect cost of a product) depends on many factors, all such factors cannot supplies by financial accounting.

    Unanimity about:

    Although there is IASC (International Accounting Standard Committee), the accountants differ in their opinion on the application of accounting principles in the same matter. For example, some accountants prefer to use the FIFO method for valuing inventory whereas others prefer to use LIFO or some other method; or, some accountants prefer to use the Straight-line Method of depreciation but others prefer to use Diminishing Balance Method, etc.

    Technical Subject:

    Since financial accounting is a technical subject, a common man can’t understand it. Without the proper knowledge of principles and conventions of accounting, it is not possible to analyze the financial data to make any financial decision. Naturally, it has got little value to a person who is not conversant with the subject.

    Impossible to Evaluate:

    Whether the existing accounting principle is sound/correct or not, that cannot be evaluated, i.e., actual performance cannot compare with the budget figure as we can do in the case of Standard Costing/Budgetary Control. In other words, the actual result cannot compare with the budget. Financial accounting presents only the result of the business through profit and financial positions, i.e., the rate of profitability. But the profit may affect by many outside factors that not record by financial accounting.

    Maybe Manipulated:

    Financial accounting may manipulate, i.e., it may present as per the desire of the management. For example, profit sometimes may reduce to evade tax and to avoid bonuses to the employees. On the contrary, more profit may show to raise fresh equity shares or to pay more dividends to attract shareholders and others.

    Supply Quantitative Information:

    Financial accounting supplies quantitative information only through absolute figures which do not present always the required information although they are needful to the users. But relative financial information is more important and informative.

    Supplies Insufficient Information:

    Financial accounting provides information about the financial activities as a whole and not individual-wise, i.e., it does not record information relating to product-wise, department-wise, etc.

    Historic in Nature:

    Since the financial accounting records all transactions relating to a particular period, it is rather historic in nature. In short, present financial information relating to a past period and not for the future although all financial decisions take base on past financial data.

    Summary:

    10 Key Financial Accounting Limitations help for Better Solution.

    • Controlling Cost Impossible.
    • Recording Actual Cost.
    • Difficulty in Price Fixation.
    • Unanimity about.
    • Technical Subject.
    • Impossible to Evaluate.
    • Maybe Manipulated.
    • Supply Quantitative Information.
    • Supplies Insufficient Information, and.
    • Historic in Nature.
    10 Key Financial Accounting Limitations help for Better Solution
    10 Key Financial Accounting Limitations help for Better Solution. Image Credit from #Pixabay.
  • Understand Capital and Revenue Expenditure in Accounting

    Understand Capital and Revenue Expenditure in Accounting

    What leads to an increase in capital in the course of business operations is income; what leads to a reduction in capital is expense or loss. But transactions also cover the acquisition of assets, like the purchase of an office building, raising a loan, payment of liabilities, etc.; all transactions are not expenses or incomes. To know the net profit earned or loss suffered, the expenses, losses, and incomes must be assembled in the Profit and Loss Account; the transactions concerning assets and liabilities will affect items in the Balance Sheet which portrays the financial position. So, what has discussed this article: Understand Capital and Revenue Expenditure in Accounting.

    The Concept of Capital and Revenue Expenditure, in the Accounting, explains why they exist in Financial Management.

    The following expenditures below are;

    Capital Expenditure:

    What is Capital Expenditure? Capital expenditures (CAPEX) refer to funds that are used by a company for the purchase, improvement, or maintenance of long-term assets to improve the efficiency or capacity of the company. Capital expenditure can be tangible, such as a copy machine, or it can be intangible, such as a patent. In many tax codes, both tangible and intangible capital expenditures are counted as assets because they have the potential to be sold if necessary.

    Revenue Expenditure:

    What is Revenue Expenditure? A revenue expenditure (REVEX) is a cost that is charged to expense as soon as the cost is incurred. By doing so, business is using the matching principle to link the expense incurred to revenues generated in the same reporting period. The amount incurred on maintaining the earning capacity of the business, The benefit of which is direct and would be in the same accounting year itself in which such expenditure has been incurred is termed as revenue expenditure.

    The Concept of Capital and Revenue Expenditure:

    Expenses, losses, and incomes are also known as revenue items since they together will show up the net profit or revenue earned. Other transactions are of capital nature. One must be clear in one’s mind regarding the nature of an item of expenditure. This is an important aspect of the matching principle and without it; financial statements cannot be properly prepared.

    Capital expenditure is that expenditure which results in the acquisition of an asset, tangible or intangible, which can be later sold and converted into cash or which results in an increase in the earning capacity of a business or which affords some other advantage to the firm.

    In a nutshell, if the benefits of expenditure are expected to accrue for a long time, the expenditure is capital expenditure. Obvious examples of capital expenditure are land, building, machinery, patents, etc. All these things stay with the business and can be used over and over again.

    Other examples are money paid for goodwill (the right to use the established name of an outgoing firm) since it will attract the old firm’s customers and, thus, result in higher sales and profits; money spent to reduce working expenses.

    For example, conve$ion of hand-driven machinery to power-driven machinery and expenditure enabling a firm to produce a large quantity of goods. Expenditure which does not result in an increase in capacity or in the reduction of day-to-day expenses is not the capital expenditure unless there is a tangible asset to show for it.

    It should be noted that all amounts spent up to the point an asset is ready for use should be treated as capital expenditure. Examples are fees paid to a lawyer for drawing up the purchase deed of land, overhaul expenses of second-hand machinery, etc. Interest on loans raised to acquire a fixed asset is particularly noteworthy.

    Such interest can be capitalized, i.e., added to the cost of the asset but only for the period before the asset is ready for use interest paid for the subsequent period cannot be capitalized. An item of expenditure whose benefit expires within the year or expenditure which merely seeks to maintain the business or keep assets in good working condition is revenue expenditure

    Examples are salaries and wages, fuel used to drive machinery, electricity used to light the factory or offices, etc. Such expenditure does not increase the efficiency of the firm, nor does it result in the acquisition of something permanent.

    The following items of expenditure seem to be revenue expenditure, but in actual practice, these are treated as capital expenditure since they lead to the business being established and run efficiently:

    • Expenses for the formation of a company—preliminary expenses.
    • Cost of issuing shares and debentures and raising loans, such as legal expenses underwriting commission, etc.
    • Interest on capital up to the point production is ready to commence, where the nature of the business is such that construction work must go on for a long period before production can start.
    • Expenses on acquisition and installation of assets, for example, legal fees to acquire property, or expenses incurred to renovate machinery bought secondhand or wages of workmen who install the machinery.

    Diminution in the value of assets due to wear and tear or passage of time is the revenue loss. For instance, a piece of machinery is bought at the beginning of the year for $ 1, 00,000; at the end of the year, its value to the business may only be $ 90,000. The diminution—known as depreciation—is a revenue loss. Stocks of materials bought will be an asset unless consumed—to the extent, the materials are used up, they will be revenue expenditure, so also the cost of goods sold.

    However, the distinction is not always easy. In actual practice, there is a good deal of difference of opinion as to whether a particular item is capital or revenue expenditure. A cinema converts its ordinary screen into one for cinemascope. Is the expenditure-revenue or capital?

    One may say that since the eating capacity of the hall does not change, the expenditure is revenue expenditure. On the other hand, it may be argued that since cinemascope pictures attract large audiences, the hall will be full oftener. Therefore, the expenditure will result in higher earnings and should be classified as capital expenditure. There is truth on both sides.

    Understand Capital and Revenue Expenditure in Accounting
    Unde$tand Capital and Revenue Expenditure in Accounting, Image credit from #Pixabay.
  • Meaning, Definition, Services, and Functions of Financial System

    Meaning, Definition, Services, and Functions of Financial System

    A financial system is a network of financial institutions, financial markets, financial instruments, and financial services that facilitate money transfer. This system includes end users of saver, arbitrator, device, and money. The level of economic development depends largely on the basis and it facilitates the economy of the prevailing financial system. Proper circulation of funds is necessary for the economic development of the country. Do you study to learn: If Yes? Then read the lot. Let’s Study Meaning, Definition, Services, and Functions of Financial System. Read this in the Hindi language: वित्तीय प्रणाली का अर्थ, परिभाषा, सेवाएं, और कार्य। 

    The concept of Financial System Discussing the topic: Meaning, Definition, Services, and Functions of Financial System.

    Use of effective circulation and wealth promotes industrial development of the country, which supports economic development. If money is not transmitted effectively in the economy, money will be seized, which will negatively affect economic development, in which the establishment and development of industries can be blocked.

    Effective circulation, effective use of money is equally important. Economic development cannot be possible if the circulated wealth is not used properly in the producing areas. The financial system helps in spreading the wealth in the economy.

    #Meaning of Financial System:

    The financial system refers to set of complex and interconnected components consisting specialized and non-specialized financial institutions, organized and unorganized financial markets, financial instruments and financial services. The aim of the financial system is to facilitate the circulation of funds in an economy.

    It is concerned about money, credit, and finance. Money refers to the medium of exchange or mode of payment. Credit refers to the amount of debt which is returned along with the interest. And the finance refers to the monetary resources comprising the own funds and debts of the state, company or a person.

    The efficient financial system and sustainable economic growth are corollaries. The financial system mobilizes the savings and channelizes them into productive activity and thus influences the pace of economic development. Economic growth is hampered for want of an effective financial system. Broadly speaking, financial system deals with three inter-related and interdependent variables, i.e., money, credit, and finance.

    #Definition of Financial System:

    According to Amit Chaudhary,

    “Financial system is the integrated form of financial institutions, financial markets, financial securities, and financial services which aim is to circulate the funds in an economy for economic growth.”

    According to Dhanilal,

    “Financial system is the set of interrelated and interconnected components consisting of financial institutions, markets, and securities.”

    The financial system provides channels to transfer funds from individuals and groups who have saved money to individuals and group who want to borrow money. Saver (refer to the lender) are suppliers of funds to borrowers in return with promises of repayment of even more funds in the future.

    Borrowers are demanders of funds for consumer durables, house, or business plant and equipment, promising to repay borrower funds based on their expectation of having higher incomes in the future. These promises are financial liabilities for the borrower-that is, both a source of funds and a claim against the borrower’s future income.

    #Services Provided by the Financial System:

    The following Services from Financial System is given below:

    Risk Sharing: 

    The Financial system provides risk sharing by allowing savers to hold many assets. It also means the financial system enables individuals to transfer risk.

    Financial markets can create instruments to transfer risk from savers to borrowers who do not like uncertainty in returns or payments to savers or investors who are willing to bear the risk.

    The ability of the financial system to provide risk-sharing makes savers more willing to buy borrowers’ IOUs. This willingness, in turn, increases borrowers’ ability to raise funds in the financial system.

    Liquidity:

    The second service that financial system provides for savers and borrowers is liquidity, which is the ease with which an asset can be exchanged for money to purchase other assets or exchanges for goods and services. Most of the savers view the liquidity as a benefit.

    If an individual needs their assets for their own consumption and investment, they can just exchange it. Liquid assets allow an individual or firm to respond quickly to new opportunities or unexpected events. Bonds, stocks, or checking accounts are created by financial assets, which have more liquid than cars, machinery, and real estate.

    Information:

    The third service of the financial system is the collection and communication of information or we can say that it is the facts about borrowers an expectation about returns on financial assets. The first informational role the financial system plays is to gather information. That includes finding out about prospective borrowers and what they will do with borrowed funds.

    Another problem that exists in most transactions is asymmetric information. This means that borrowers possess information about their opportunities or activities that they don’t disclose to lenders or creditors and can take advantage of this information. The second informational role that financial system plays is communication of information.

    Financial markets do that job by incorporating information into the prices of stocks, bonds, and other financial assets. Savers and borrowers receive the benefits of information from the financial system by looking at asset returns. As long as financial market participants are informed, the information works its way into asset returns and prices.

    #Functions of Financial System:

    Functions and Role of the financial system, market are given below.

    • Pooling of Funds.
    • Capital Formation.
    • Facilitates Payment.
    • Provides Liquidity.
    • Short and Long-Term Needs.
    • Risk Function.
    • Better Decisions.
    • Finances Government Needs, and.
    • Economic Development.

    Now each one Functions of the financial system are discussing on brief:

    Pooling of Funds:

    In a financial system, the Savings of people are transferred from households to business organizations. With these production increases and better goods are manufactured, which increases the standard of living of people.

    Capital Formation:

    Business requires finance. These are made available through banks, households and different financial institutions. They mobilize savings which leads to Capital Formation.

    Facilitates Payment:

    The financial system offers convenient modes of payment for goods and services. New methods of payments like credit cards, debit cards, cheques, etc. facilitate quick and easy transactions.

    Provides Liquidity:

    In the financial system, liquidity means the ability to convert into cash. The financial market provides the investors the opportunity to liquidate their investments, which are in instruments like shares, debentures, bonds, etc. Price is determined on the daily basis according to the operations of the market forces of demand and supply.

    Short and Long-Term Needs:

    The financial market takes into account the various needs of different individuals and organizations. This facilitates optimum use of finances for productive purposes.

    Risk Function:

    The financial markets provide protection against life, health, and income risks. Risk Management is an essential component of a growing economy.

    Better Decisions:

    Financial Markets provide information about the market and various financial assets. This helps the investors to compare different investment options and choose the best one. It helps in decision making in choosing portfolio allocations of their wealth.

    Finances Government Needs:

    The government needs a huge amount of money for the development of defense infrastructure. It also requires finance for social welfare activities, public health, education, etc. This is supplied to them by financial markets.

    Economic Development:

    India is a mixed economy. The Government intervenes in the financial system to influence macroeconomic variables like interest rate or inflation. Thus, credits can be made available to corporate at a cheaper rate. This leads to the economic development of the nation.

    #Main Functions of Financial System:

    The functions of the financial system can be enumerated as follows:

    • The financial system acts as an effective conduit for optimal allocation of financial resources in an economy.
    • It helps in establishing a link between savers and investors.
    • The financial system allows ‘asset-liability change’. When they accept deposits from customers, banks make claims against themselves, but they also make assets when providing loans to customers.
    • Economic resources (i.e., money) are transferred from one party to another through the financial system.
    • The financial system ensures the efficient functioning of the payment mechanism in the economy. All transactions between buyers and sellers of goods and services are easily affected due to the financial system.
    • In the case of mutual funds, the financial system helps in risk change by diversification.
    • The financial system increases the liquidity of financial claims.
    • The financial system helps in finding the prices of financial assets from the
    • contact of buyers and sellers. For example, the value of the securities is determined by capital market demand and supply forces.
    • The financial system helps reduce the cost of transactions.

    As discussed above, financial markets play an important role in economic development through the role of capital allocation capital, supervising managers, saving savings and promoting technological change among others. Economists had thought that the development of the financial sector is an important element to encourage financial growth.

    Financial development can be defined as the ability to obtain information effectively in the financial sector, implement contracts, facilitate transactions, and promote special types of financial contracts, markets, and arbitrators. Should be at a lower cost.

    Financial development occurs when financial tools, markets, and intermediaries improve on the basis of information, enforcement and transaction costs, and therefore provide better financial services. Financial work or services can affect the economy’s savings and investment decisions through capital accumulation and technical innovation and therefore economic growth.

    Capital accumulation can be modeled either through capital peripherals or capital goods, which are produced using constant returns, but without the use of any reproduction factors to stabilize static per-state growth.

    Through capital accumulation, the steady growth rate in the work done by the financial system affects the rate of capital formation. The financial system affects capital accumulation either by either changing the savings rate or by reallocating the savings between capital production levels. Through technological innovation, focus on innovation of new production processes and inventions.

    Because friction of the market and laws, rules and policies are quite different with the economies and the times, the impact of financial development on development can have different effects for the economy allocation and welfare in the economy. Read this in the Hindi language: वित्तीय प्रणाली का अर्थ, परिभाषा, सेवाएं, और कार्य। 

    Meaning Definition Services and Functions of Financial System
    Meaning, Definition, Services, and Functions of Financial System.
  • Financial Accounting Importance, Nature, and Limitations

    Financial Accounting Importance, Nature, and Limitations

    Financial accounting Importance, Nature, and Limitations; It is a system that collects information, processes, and reports about changes in the performance, financial status, and financial status of an entity. A person’s ability to track the financial transactions of a person’s business, during which, he knows as financial accounting skills as a result of his operation. Do you study to learn: If Yes? Then read the lot. Let’s Study Financial Accounting Importance, Nature, and Limitations.

    Every Company Current year or the end of the year want to know the financial status of the business. Financial Accounting Importance, Nature, and Limitations.

    It is done by recording, summarizing, and presenting all such financial figures in the form of financial reports or statements using standardized guidelines. Such financial statements generally include balance sheets, income details, and cash flow details; which summarize a company’s performance over time. Financial accounting skills generally do not include the ability to report the value of a company but can provide enough information for the evaluation of others.

    Definition of Financial Accounting:

    Financial Accounting concerns with providing information to external users. It refers to the preparation of general-purpose reports for use by persons outside a business enterprise, such as shareholders (existing and potential), creditors, financial analysts, labor unions, government authori­ties, and the like. Financial accounting is oriented towards the preparation of financial statements which summarise the results of operations for selected periods of time and show the financial position of the business at particular dates.

    Every entity, whether for-profit or not-for-profit; aims at creating maximum value for its stakeholders. The goal of maximum value addition best achieves; when there is a mechanism to monitor the management and the board of directors. Financial accounting helps in such monitoring by providing relevant, reliable, and timely information to the stakeholders.

    Inputs to a financial accounting system include business transactions that are supported by source documents, such as invoices, board resolutions, management memos, etc. These inputs are processed using generally accepted accounting principles (GAAP). The processed information is reported through standardized financial statements.

    Importance of Financial Accounting:

    Financial accounting is integral to companies of all sizes because it helps in the following importance below are: They are three important points.

    1. Communication of information externally.
    2. Communicate information internally, and.
    3. Comparison through analysis.
    First Point:

    This point explains Communication on information externally. The statements and reports generated by financial accounting use to communicate information about the overall health and well-being of the company to external parties. Such external users may include suppliers, banks, and leasing companies, etc. who are not part of the company but require all this information to analyze the progress of the company and compare it with their expectations.

    Second Point:

    This point explains Communicate on information internally. A company’s finance team or its employees who are interested in stock-based compensation etc. constitute the internal users of the information generated by financial accounting practices. The reports generated with the help of financial accounting skills are helpful for this purpose as well.

    Last Point:

    This point explains Comparison through analysis. Since financial accounting requires the use of standardized guidelines, the financial statements generated by all companies are comparable, providing a standard method of analysis.

    Scope and Nature of Financial Accounting:

    The following points are important to understand the scope and nature of financial accounting:

    Contents:

    The end product of the financial accounting process is the financial statements that communicate useful information to decision-makers. The financial statements reflect a combination of recorded facts, accounting conventions, and personal judgments of the preparers. There are three primary financial statements for a profit-making entity in India, viz., the Income Statement (statement of revenues, expenses, and profit), and the Balance Sheet (like the statement of assets, liabilities, and owner’s equity) and cash flow statement. The accounting information generated by financial accounting is quantitative, formal, structured, numerical, and past-oriented material.

    Accounting System:

    The accounting system includes the various techniques and procedures used by the accountant (preparer) in measuring, describing, and communicating financial data to users. Journals, ledgers, and other accounting techniques used in processing financial accounting information depend upon the concept of the double-entry system. This technique includes generally accepted accounting princi­ples (GAAP). The standard of generally accepted accounting principles includes not only broad guidelines of general application but also detailed practices and procedures.

    Measurement Unit:

    Financial accounting primarily concerns with the measurement of economic resources and obligations and changes in them. Financial accounting measures in terms of monetary units of a society in which it operates. For example, the common denominator or yardstick used for accounting measurement is the rupee in India and the dollar in the U.S.A. The assumption is that the rupee or the dollar is a useful measuring unit.

    Users of Financial Accounting Information:

    Financial accounting information intends primarily to serve external users. Some users have a direct interest in the reported information. Examples of such users are owners, credi­tors, potential owners, suppliers, management, tax authorities, employees, customers. Some users need financial accounting information to help those who have a direct interest in a business enterprise.

    Examples of such users are financial analysts and advisers, stock exchanges, financial press and reporting agencies, trade associations, labor unions. These user groups having direct/indirect interests have different objectives and diverse informational needs. The emphasis in financial accounting has been on general-purpose information which, obviously, is not intended to satisfy any specialized needs of individual users or specific user groups.

    Users or Role in Financial Accounting:

    The most basic motives or objectives of financial accounting is the preparation of general-purpose financial statements; which are financial statements meant for use by stakeholders external to the entity; who do not have any other means of getting such information, i.e. people other than the management. These stakeholders include:

    Investors and Financial Analysts:

    Investors need the information to estimate the intrinsic value of the entity and to decide whether to buy, hold, or sell the entity’s shares. Equity research analysts use financial statements to conduct their research on earnings expectations and price targets.

    Working as Employee groups:

    Employees and their representative groups interest in information about the solvency and profitability of their employers to decide about their careers, assess their bargaining power and set a target wage for themselves.

    Lead as Lenders:

    Lender’s interest in the information enables them to determine whether their loans and the interest earned on them will pay when due.

    Suppliers and other trade creditors:

    Suppliers and other creditors interest in the information that enables them to determine whether amounts owing to them will pay when due and whether the demand from the company is going to increase, decrease, or stay constant.

    One of the Customers:

    Customers want to know whether their supplier is going to continue as an entity; especially when they have a long-term involvement with that supplier. For example, Apple interests in the long-term viability of Intel because Apple uses Intel processors in its computers and if Intel ceases operations at once; Apple will suffer difficulties in meeting its own demand and will lose revenue.

    His also Governments and their agencies:

    Governments and their agency’s interest in financial accounting information for a range of purposes. For example, the tax collecting authorities, such as IRS in the USA, interest in calculating the taxable income of the tax-paying entities and finding their tax payable. Antitrust authorities, such as the Federal Trade Commission, interest in finding out whether an entity engages in monopolization.

    The governments themselves interest in the efficient allocation of resources; and, they need financial accounting information of different sectors and industries to decide on federal and state budget allocation, etc. The bureaus of statistics are interested in calculating national income, employment, and other measures.

    Also Public:

    The public interests in an entity’s contribution to the communities in which it operates; its corporate social responsibility updates; its environmental track record, etc.

    Limitations of Financial Accounting:

    Financial accounting is significant for management as it helps them to direct and control the firm activities. It also helps business management in determining appropriate managerial policies in different areas, such as production, sales, administration, and finance.

    Financial accounting suffers from the following limitations which have been responsible for the emergence of cost and manage­ment accounting:

    • Financial accounting does not provide detailed cost information for different departments, processes, products, jobs in the production divisions. Management may need information about different products, sales territories; and, sales activities which are also not available in financial accounting.
    • Financial accounting does not set up a proper system of controlling materials and supplies. Undoubtedly, if material and supplies do not control in a manufacturing concern; they will lead to losses on account of misappropriation, misutilization, scrap, defectives, etc.
    • The recording and accounting for wages and labor are not done for different jobs, processes, products, departments. This creates problems in analyzing the costs associated with different activities.
    • It is difficult to know the behavior of costs in financial accounting as expenses not classify as direct; and, indirect and therefore cannot classify as controllable and uncontrol­lable. Cost management which is the most important objective of all business enterprises; cannot achieve with the aid of financial accounting alone.
    • Financial accounting does not possess an adequate system of standards to evaluate the per­formance of departments and employees working in departments. Standards need to develop for materials, labor, and overheads so that a firm can compare the work of workers, supervisors, and executives with what should have been done in an allotted period of time.
    Other limitations:
    • Financial accounting contains historical cost information that accumulates at the end of the accounting period. The historical cost is not reliable for predicting future earnings, solvency, or overall managerial effectiveness. Historical cost information is relevant but not adequate for all purposes.
    • Financial accounting does not provide information to analyze the losses due to various factors; such as idle plant and equipment, seasonal fluctuations in the volume of business, etc. It does not help management in taking important decisions about the expansion of business, dropping of a product, alternative methods of production, improvement in product, etc.
    • Also, Financial accounting does not provide the necessary cost data to determine the price of the product being manufactured or the service being rendered to the consumers.

    Despite the above limitations, financial accounting has utility and is an important and conceptually rich area. Because of growing business complexities and advances in knowledge of human behavior and decision processes; the scope and methods of financial accounting are chang­ing. Financial accounting theory and practice will probably broaden and improve considerably in the future.

    Financial Accounting Importance Nature and Limitations
    Financial Accounting Importance, Nature, and Limitations.
  • What is Financial Accounting? Meaning and Definition

    What is Financial Accounting? Meaning and Definition

    Meaning of Financial Accounting: Financial accounting is an area of accounting that focuses on providing useful information to external users. Accounting, in your heart, is actually a set of very simple concepts and principles. Once you understand the basics of accounting, you will be able to understand any business or accounting concept. Accounting in general deals, identifying business activities, like sales to customers, recording these activities, like journalism, and transmitting these activities with people outside the organization with financial activities. Do you study to learn: If Yes? Then read the lot. What is Financial Accounting? Meaning and Definition.

    Explains – What is Financial Accounting? Meaning and Definition.

    Financial accounting is a special branch of accounting that keeps track of the financial transactions of a company. Using the standardized guidelines, transactions have been recording in financial statements such as financial reports or income details or balance sheets, briefly presenting. Financial accounting, however, is a subdivision of the general area of accounting that focuses on gathering and compiling data to present external users in a usable form. So what does that mean? In fact, the main purpose of financial accounting is to provide usefully; financial information outside those people or organizations that often call external users.

    Definition of Financial Accounting:

    Financial Accounting is concerned with providing information to external users. It refers to the preparation of general-purpose reports for use by persons outside a business enterprise, such as shareholders (existing and potential), creditors, financial analysts, labor unions, government authori­ties, and the like. Financial accounting is oriented towards the preparation of financial statements; which summarise the results of operations for selecting periods of time and show the financial position of the business at particular dates.

    As well as the definition of Accounting.

    According to R.N Anthony:

    “Nearly every business enterprise has the accounting system. It is a means of collecting, summarizing, analyzing and reporting in monetary terms, information’s about business.”

    According to Smith and Ashburne:

    “Accounting is the art of recording, classifying and summarizing in a significant manner and in terms of money, transactions, and events, which are, in part at least, of a financial character and interpreting the result thereof.”

    The ability of an individual to keep track of the financial transactions of a business; resulting from its operation over a period of time, is knowing as his financial accounting skills. This is done by recording, summarizing, and presenting all such financial data in the form of financial reports or statements, using standardizes guidelines.

    Such financial statements usually include the balance sheet, income statement, and cash flow statement; which summarize the performance of a company’s operations over a period of time. Financial accounting skills usually do not encompass the ability to report the value of a company; but, to be able to provide sufficient information for others to assess it themselves.

    Meaning and Definition

  • Financial Accounting: Meaning, Nature, and Scope

    Financial Accounting: Meaning, Nature, and Scope

    Financial accounting is a specialized branch of accounting that keeps track of a company’s financial transactions. Define with Explain it each one Concept of Financial Accounting Discuss the topic, Financial Accounting – Meaning, Definition, Nature, Scope, and Disadvantages of Limitations. Using standardized guidelines, the transactions record, summarize, and present in a financial report or financial statements such as an income statement or a balance sheet. Companies issue financial statements on a routine schedule. The statements are considered external because they are given to people outside of the company, with the primary recipients being owners/stockholders, as well as certain lenders. It also learns Accountability in Financial Management.

    Learn, Explain Financial Accounting: Meaning, Nature, Scope, and Disadvantages. 

    If a corporation’s stock is publicly traded, however, its financial statements [Hindi] (and other financial reporting) tend to widely circulate, and information will likely reach secondary recipients such as competitors, customers, employees, labor organizations, and investment analysts. It’s important to point out that the purpose of financial accounting is not to report the value of a company. Rather, its purpose is to provide enough information for others to assess the value of a company for themselves.

    Because external financial statements are used by a variety of people in a variety of ways, financial accounting has common rules known as accounting standards and as generally accepted accounting principles (GAAP). In the U.S., the Financial Accounting Standards Board (FASB) is an organization that develops accounting standards and principles. Corporations whose stock publicly trade must also comply with the reporting requirements of the Securities and Exchange Commission (SEC), an agency of the U.S. government. The similarity between Financial and Management Accounting.

    Meaning of Financial Accounting: 

    Accounting is the process of recording, classifying, summarizing, analyzing, and interpreting the financial transactions of the business for the benefit of management and those parties who are interested in business such as shareholders, creditors, bankers, customers, employees, and government. Thus, it concerns with financial reporting and decision-making aspects of the business.

    The American Institute of Certified Public Accountants Committee on Terminology proposed in 1941 that accounting may be defined as,

    “The art of recording, classifying and summarizing in a significant manner and in terms of money, transactions, and events which are, in part at least, of a financial character and interpreting the results thereof.”

    Financial Accounting:

    The term ‘Accounting’ unless otherwise specifically stated always refers to ‘Financial Accounting’. It is commonly carrying on in the general offices of a business. It concerns with revenues, expenses, assets, and liabilities of a business house. Also, they have the two-fold objective, viz,

    • To ascertain the profitability of the business, and
    • To know the financial position of the concern.

    Nature and Scope of Financial Accounting:

    Financial accounting is a useful tool to manage and to external users such as shareholders, potential owners, creditors, customers, employees, and government. It provides information regarding the results of its operations and the financial status of the business.

    The following are the functional areas of financial accounting:-

    1] Dealing with financial transactions:

    Accounting as a process deals only with those transactions which are measurable in terms of money. Anything which cannot be expressed in monetary terms does not form part of financial accounting however significant it is.

    2] Recording of information:

    Accounting is the art of recording financial transactions of a business concern. There is a limitation on human memory. It is not possible to remember all transactions of the business. Therefore, the information is recorded in a set of books called Journal and other subsidiary books and it is useful for management in its decision-making process.

    3] Classification of Data:

    The recorded data arrange in a manner to group the transactions of similar nature at one place so that full information of these items may collect under different heads. This is done in the book called ‘Ledger’. For example, we may have accounts called ‘Salaries’, ‘Rent’, ‘Interest’, Advertisement’, etc. To verify the arithmetical accuracy of such accounts, the trial balance prepare.

    4] Making Summaries:

    The classified information of the trial balance uses to prepare a profit and loss account and balance sheet in a manner useful to the users of accounting information. As well as, the final accounts prepare to find out the operational efficiency and financial strength of the business.

    5] Analyzing:

    It is the process of establishing the relationship between the items of the profit and loss account and the balance sheet. Also, the purpose is to identify the financial strength and weaknesses of the business. It also provides a basis for interpretation.

    6] Interpreting financial information:

    It is concerned with explaining the meaning and significance of the relationships established by the analysis. It should be useful to the users, to enable them to take correct decisions.

    7] Communicating the results:

    The profitability and financial position of the business as interpreted above communicate to the interest parties at regular intervals to assist them to make their conclusions.

    Disadvantages or Limitations of Financial Accounting:

    The concerns with the preparation of final accounts. Also, the business has become so complex that mere final accounts are not sufficient for meeting financial needs. It is like a post-mortem report. At the most, it can reveal what has happened so far, but it cannot exercise any control over the past happenings.

    The disadvantages of financial accounting are as follows:-

    1. It records only quantitative information.
    2. Records only the historical cost. The impact of future uncertainties has no place in financial accounting.
    3. It does not take into account price level changes.
    4. It provides information about the whole concern. Product-wise, process-wise, department-wise, or information of any other line of activity cannot obtain separately from financial accounting.
    5. Cost figures do not know in advance. Therefore, it is not possible to fix the price in advance. It does not provide information to increase or reduce the selling price.
    6. As there is no technique for comparing the actual performance with that of the budgeted targets, it is not possible to evaluate the performance of the business.
    7. It does not tell about the optimum or otherwise of the quantum of profit made and does not provide the ways and means to increase the profits.
    In other words;
    1. In case of loss, whether loss can reduce or convert into profit using cost control and cost reduction? It does not answer this question.
    2. Does it not reveal which departments are performing well? Which ones are incurring losses and how much is the loss in each case?
    3. It does not provide the cost of products manufactured
    4. There are no means provided by financial accounting to reduce the wastage.
    5. Can the expenses reduce which results in the reduction of product cost and if so, to what extent and how? No answer to these questions.
    6. It is not helpful to the management in taking strategic decisions like a replacement of assets, an introduction of new products, discontinuation of an existing line, expansion of capacity, etc.
    7. It provides ample scope for manipulation like overvaluation or undervaluation. This possibility of manipulation reduces reliability.
    8. It’s technical. A person not conversant with accounting has little utility of the financial accounts.

    Financial Accounting Meaning Nature and Scope