Tag: Statement

  • Fund Flow Statement: Explanation, Importance, and Structure

    Fund Flow Statement: Explanation, Importance, and Structure

    What does the Fund Flow Statement mean? Funds flow statement is the statement of sources and uses of the fund. Fund Flow Statement: Explanation, Importance, and Structure. Funds flow statement shows the source from which the funds are received and the areas to which they obtained funds have been utilized. Funds flow statement indicates various mean by which funds were received during a particular period and the ways in which these funds were applied. Also learned, Venture Capital: Introduction, Definition, Characteristics, Advantages, and Disadvantages.

    The Concept of Fund Flow Statement.

    The topic is studying; Explanation of Fund Flow Statement, Meaning of Fund Flow Statement, Definition of Fund Flow Statement, Importance of Fund Flow Statement, and Structure of Fund Flow Statement. Funds flow statement comprises three words- fund, flow, and statement. “Fund” means the financial resources used by a concern. In the sense of working capital. The excess current asset over the current liabilities is called net working capital.

    Similarly. The term “Flow” means the movement of funds and includes both inflows (receipt) and outflows (payments) of found. Funds from the operation, issue of share and debentures, additional long term debt, non-operating revenues etc. are considered as the major sources of fund. Increase in working capital, the redemption of the debenture, repayment of the long term loan, payment for non-operating expenses etc. are the amine areas of uses of the fund.

    The term “Statement” represents the format or account under which the flows of fund i.e. cash inflows and outflows are recorded. Funds flow statement is known by various names such as statements of sources and uses of funds, the summary of financial operations, which got and where go statement, movement of the working capital statement, funds received and disbursement statement etc.

    #Explanation of Fund Flow Statement:

    The balance sheet and income statement are the traditional basis financial statements of concern. They furnish useful financial information regarding the operation of the concern; however, a serious limitation of these statements is that they fail to provide of time regarding changes in the financial position of a concern during a particular period of time. Funds flow statement, which is known as the statement of changes in financial position, overcomes these limitations of traditional financial statements.

    Funds flow statement is the statement of sources and uses of the fund. Funds flow statement shows the source from which the funds are received and the areas to which they obtained funds have been utilized. Funds flow statement indicates various mean by which funds were received during a particular period and the ways in which these funds were applied.

    Meaning of Fund Flow Statement:

    A fund flow statement is a statement in summary form that indicates changes in terms of financial position between two different balance sheet dates showing clearly the different sources from which funds are obtained and uses to which funds are put. The profit and loss account and balance sheet statements are the common important accounting statements of a business organization.

    The profit and loss account provides financial information relating to only a limited range of financial transactions entered into during an accounting period and its impact on the profits to be reported. The balance sheet contains information relating to capital or debt raised or assets purchased. But both the above two statements do not contain a sufficiently wide range of information to make an assessment of the organization by the end user of the information.

    In view of the recognized importance of capital inflows and outflows, which often involve large amounts of money should be reported to the stakeholders, the funds flow statement is devised. In funds flow analysis, the details of financial resources availed and the ways in which such resources are used during a particular accounting period, are given in a statement form called “Funds flow statement”.

    The sources of funds also include the funds generated from operations internally. The funds flow statement can explain the reasons for the liquidity problems of the firm even though it is earning profits. It helps the efficient working capital management and indicates the ability of the firm in servicing its long-term debt obligations. The changes in working capital position can also be tracked by observing the surplus/deficit of funds during a particular accounting period.

    Definition of Fund Flow Statement:

    Funds Flow Statement is a method by which we study changes in the financial position of a business enterprise between the beginning and ending financial statements dates. It is a statement showing sources and uses of funds for a period of time.

    Some definitions of financial experts are given for the clear conception of fund flow statement:

    Foulke defines these statements as:

    “A statement of sources and application of funds is a technical device designed to analyze the changes in the financial condition of a business enterprise between two dates.”

    According to R. N. Anthony:

    “The fund’s flow statement describes the sources from which additional funds were derived and the use to which these sources were put.”

    I.C.W.A. in Glossary of Management Accounting terms defines Funds Flow Statement as,

    “A Statement prospective or retrospective, setting out the sources and applications of the funds of an enterprise. The purpose of the statement is to indicate clearly the requirement of funds and how they are proposed to be raised and the efficient utilization and application of the same.”

    Roy A. Fouke defines a fund flow statement as,

    “A statement of sources and application of funds is a technical device designed to analyze the changes in the financial condition of a business enterprise between two dates.”

    Thus, the fund flow statement reveals the volume of financial transactions and explains the flow of funds taking place within a business during a particular period of time and its effect on the net working capital. It is not a substitute for either the Profit and Loss Account or the Balance Sheet, but it is a useful supplement to them. It describes the sources from which funds are obtained and the uses of these funds, in a condensed form.

    #Importance of Fund Flow Statement:

    A funds flow statement is an essential tool for financial analysis and is of primary importance to financial management. Nowadays, it is being widely used by the financial analysts, credit granting institutions and financial managers.

    The basic purpose of a funds flow statement is to reveal the changes in the working capital on the two balance sheet dates. It also describes the sources from which additional working capital has been financed and the uses to which working capital has been applied.

    The importance of fund flow statement may be summarised:

    Analyses Financial Statements:

    Balance Sheet and Profit and Loss Account do not reveal the changes in the financial position of an enterprise. Fund flow analysis shows the changes in the financial position between two balance sheet dates. It provides details of inflow and outflow of funds i.e., sources and application of funds during a particular period.

    Hence it is a significant tool in the hands of the management for analyzing the past, and for planning the future. They can infer the reasons for imbalances in the uses of funds in the past and take corrective measures for the future.

    Answers Various Financial Questions:

    Fund flow statement helps us to answers various financial questions such as:

    • How many funds flowed into the business?
    • How much of these funds were provided by the operations?
    • What are the other sources of funds?
    • How were these funds used?
    • Why was there less/more amount of net working capital at the end of the period than at the beginning?
    • Why were the dividends not larger?
    • How was the purchase of fixed assets financed?
    • Where has the net profit is gone?
    • How were the loans repaid?

    Rational Dividend Policy:

    Sometimes it may happen that a firm, instead of having sufficient profit, cannot pay dividend due to inadequate working capital. In such circumstances, fund flow statement shows the working capital position of a firm and helps the management to take policy decisions on dividend etc.

    Proper Allocation of Resources:

    Financial resources are always limited. So it is the duty of the management to make its proper use. A projected fund flow statement enables the management to take the proper decision regarding allocation of limited financial resources among different projects on a priority basis.

    Guide to Future Course of Action:

    The future needs of the fund for various purposes can be known well in advance from the projected fund flow statement. Accordingly, timely action may be taken to explore various avenues of the fund. A projected funds flow statement also acts as a guide for the future to the management.

    The management can come to know the various problems it is going to face in near future for want of funds. The firm’s future needs of funds can be projected well in advance and also the timing of these needs. The firm can arrange to finance these needs more effectively and avoid future problems.

    Proper Managing of Working Capital:

    It helps the management to know whether working capital has been effectively used to the maximum extent in business operations or not. It depicts the surplus or deficit in working capital than required. This helps the management to use the surplus working capital profitably or to locate the resources of additional working capital in case of scarcity. A funds flow statement helps in explaining how efficiently the management has used its working capital and also suggests ways to improve the working capital position of the firm.

    Guide to Investors:

    It helps the investors to know whether the funds have been used properly by the company. The lenders can make an idea regarding the creditworthiness of the company and decide whether to lend money to the company or not.

    Evaluation of Performance:

    Fund flow statement helps the management in judging the financial and operating performance of the company.

    Fund Flow Statement Explanation Importance and Structure
    Fund Flow Statement: Explanation, Importance, and Structure, #Pixabay.

    #Structure of Fund Flow Statement:

    The structure of fund flow statement like other accounting statements is based on the equality of financial assets and liabilities.

    To bring the form of fund flow statement on a scientific line, the fund flow statement is divided into two parts:

    • Schedule of working capital changes, and.
    • Statement of sources and uses of the fund.

    Now explain;

    Schedule of Working Capital Changes:

    This schedule is also called “Comparative Change in Working Capital Statement” of “Statement of Working Capital Changes” or “Working Capital Variation Statement” or “Net Current Assets Account” or “Working Capital Account”. The increase in working capital is treated as use of fund and decrease in working capital is termed as sources of fund.

    This statement or schedule is prepared in such a way or form as to indicate the amount of working capital at the end of two years as well as increase or decrease in the individual items of current assets and current liabilities.

    The following rules should be taken into account while ascertaining the increase or decrease in individual items of current assets and current liabilities and its impact on working capital:

    • Increase in the items of Current Assets will increase the Working Capital.
    • The decrease in the items of Current Assets will decrease the Working Capital.
    • Increase in the items of Current Liabilities will decrease the Working Capital.
    • The decrease in the items of Current Liabilities will increase the Working Capital.

    Statement of Sources and Uses of Fund:

    This is the second but most important part of Fund Flow Statement. It is prepared on the basis of the changes in Fixed Assets. The preparation of Statement of Sources and Uses of Fund involves the ascertainment of increase/decrease in the various items of fixed assets, long term liabilities and share capital in the light of additional information given below.

    To give an idea of the different items of sources and uses, the probable items of sources and uses of the fund are tabulated below.

    Sources of Fund:

    The following sources below are;

    • An issue of fresh shares (derived from an increase in share capital).
    • The Issue of Debentures (derived from the increase in debentures).
    • Raising of new loans (derived from the increase in long term loans).
    • Sale of fixed assets for cash or for other current assets (derived from the decrease in fixed assets and additional information).
    • Non-trading income.
    • Profit from operations (before deducting non-cash items of expenses and losses and before adding non-cash, non-trading income), and.
    • The decrease in working capital (derived from the schedule of working capital changes).
    Uses of Fund:

    The following uses below are;

    • Redemption of Preference Shares in cash (derived from the decrease in share capital).
    • Redemption of debentures in cash (derived from the decrease in debentures).
    • Repayment of loans (derived from the decrease in long-term loans).
    • Purchase of fixed assets for consideration other than shares, debentures or long term debt (derived from the increase in fixed assets and additional information).
    • Loss from operations.
    • Payment of dividend in cash, and.
    • Increase in working capital (derived from the schedule of working capital changes).
  • 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.
  • Explanation of Financial Statements: Objectives, Importance, and Limitations

    Explanation of Financial Statements: Objectives, Importance, and Limitations

    Financial statements are the product of a process in which a large volume of data about aspects of the economic activities of an enterprise are accumulated, analyzed and reported. Explanation of Financial Statements: Objectives, Importance, and Limitations – Keep study and learn. This process should carry out in conformity with generally accepted accounting principles. These principles represent the most current consensus about how accounting information should record, what information should be disclosed, how it should be disclosed, and which financial statement should prepare.

    Financial Statements explanation of each, Meaning of Financial Statements, Objectives of Financial Statements, Importance, and Limitations of Financial Statements.

    Thus, generally accepted principles and standards provide a common financial language to enable informed users to read and interpret financial statements. Financial statements are prepared primarily for decision-making. They play a dominant role in setting the framework of managerial decisions. But the information provided in the financial statements is not an end in itself as no meaningful conclusions can draw from these statements alone.

    However, the information provided in the financial statements is of immense use in making decisions through analysis and interpretation of financial statements. Financial analysis is the process of identifying the financial strengths and weaknesses of the firm by properly establishing the relationship between the items of the balance sheet and the profit and loss account. There are various methods or techniques used in analyzing financial statements, such as comparative statements, common-size statements, trend analysis, schedule of changes in working capital, funds flow, cash flow analysis, and ratio analysis. Related learn Financial Accounting: Meaning, Nature, and Scope!

    Meaning of Financial Statements: 

    Financial Statements are the collective name given to Income Statement and Positional Statement of an enterprise which shows the financial position of a business concern in an organized manner. We know that all business transactions are first recorded in the books of original entries and thereafter posted to relevant ledger accounts. For checking the arithmetical accuracy of books of accounts, a Trial Balance is prepared.

    The trial balance is a statement prepared as a first step before preparing financial statements of an enterprise which record all debit balances in the debit column and all credit balances in the credit column. To find out the profit earned or loss sustained by the firm during a given period and its financial position at a given point in time is one of the purposes of accounting. For achieving this objective, financial statements are prepared by the business enterprise, which includes the income statement and positional statement.

    A firm communicates to the users through financial statements and reports.  The financial statements contain summarized information on the firm’s financial affairs, organized systematically. Preparation of the financial statements is the responsibility of top management.  They should prepare very carefully and contain as much information as possible.

    Two basis financial statements prepared for external reporting to owners, investors, and creditors are:
    1. Statement of financial position (or Balance sheet): Balance sheet contains information about the resources and obligations of a business entity and about its owners’ interests in the business at a particular point in time. In accounting’s terminology, balance sheet communicates information about assets, liabilities and owner’s equity for a business firm as on a specific date.  It provides a snapshot of the financial position of the firm at the close of the firm’s accounting period.
    2. Income statement (or Profit and loss account): The profit and loss account presents the summary of revenues, expenses and net income (or net loss) of a firm for some time. Net income is the amount by which the revenues earned during a period exceed the expenses incurred during that period.

    More information is required for planning and controlling and therefore the financial accounting information is presented in different statements and reports in such a way as to serve the internal needs of management.  Financial statements are prepared from the accounting records maintained by the firm.

    These two basic financial statements viz:

    (i) Income Statement,  or Trading, and Profit & Loss Account and (ii) Positional Statement, or Balance Sheet portrays the operational efficiency and solvency of any business enterprise.

    The following formula summarizes what a balance sheet shows:

    ASSETS = LIABILITIES + SHAREHOLDER’S EQUITY

    A company’s assets have to equal, or “balance,” the sum of its liabilities and shareholder’s equity.

    The income statement shows the net result of the business operations during an accounting period and positional statement, a statement of assets and liabilities, shows the final position of the business enterprise on a particular date and time. So, we can also say that the last step of the accounting cycle is the preparation of financial statements.

    The income statement is another term used for Trading and Profit & Loss Account. It determines the profit earned or loss sustained by the business enterprise during a period. In the large business organization, usually one account i.e., Trading and Profit & Loss Account is prepared for knowing gross profit, operating profit, and net profit.

    On the other hand, in small size organizations, this account is divided into two parts i.e. Trading Account and Profit and Loss Account. To know the gross profit, Trading Account is prepared and to find out the operating profit and net profit, Profit and Loss Account is prepared. The positional statement is another term used for the Balance Sheet. The position of assets and liabilities of the business at a particular time is determined by the Balance Sheet.

    Objectives of financial statements are:

    • To provide reliable financial information about economic resources and obligations of a business enterprise.
    • Reliable information about changes in the resources (resources minus obligations) of an enterprise that result from the profit-directed activities.
    • Financial information that assists in estimating the earning potential of the enterprise.
    • Other needed information about changes in economic resources and obligations.
    • To disclose, to the extent possible, other information related to the financial statement that is relevant to statement users

    Objective and Importance:

    The profitability of Business:

    Financial statements are required to ascertain whether the enterprise is earning the adequate profit and to know whether the profits have increased or decreased as compared to the previous years so that corrective steps can be taken well in advance.

    The Solvency of the Business:

    Financial statements help to analyze the position of the business as regards to the capacity of the entity to repay its short as well as long-term liabilities.

    The Growth of the Business:

    Through comparison of data of two or more years of business entity, we can draw a meaningful conclusion about the growth of the business. For example, an increase in sales with a simultaneous increase in the profits of the business indicates a healthy sign for the growth of the business.

    Financial Strength of Business:

    Financial statements help the entity in determining the solvency of the business and help to answer various aspects viz., whether it is capable to purchase assets from its resources and/or whether the entity can repay its outside liabilities as and when they become due.

    Making Comparison and Selection of Appropriate Policy:

    To make a comparative study of the profitability of the entity with other entities engaged in the same trade, financial statements help the management to adopt the sound business policy by making Intra firm comparison.

    Forecasting and Preparing Budgets:

    The financial statement provides information regarding the weak-spots of the business so that the management can take corrective measures to remove these shortcomings. Financial statements help the management to make the forecast and prepare budgets.

    Communicating with Different Parties:

    Financial statements are prepared by the entities to communicate with different parties about their financial position. Hence, it can be concluded that understanding the basic financial statements is a necessary step towards the successful management of a commercial enterprise.

    Limitations of Financial Statements:

    Manipulation or Window Dressing:

    Some business enterprises resort to manipulating the information contained in the financial statements to cover up their bad or weak financial position. Thus, the analysis based on such financial statements may be misleading due to window dressing.

    Use of Diverse Procedures:

    There may be more than one way of treating a particular item and when two different business enterprises adopt different accounting policies, it becomes very difficult to make a comparison between such enterprises. For example, depreciation can be charged under the straight-line method or written down value method. However, the results provided by comparing the financial statements of such business enterprises would be misleading.

    Qualitative Aspect Ignored:

    The financial statements incorporate the information which can be expressed in monetary terms. Thus, they fail to assimilate the transactions which cannot be converted into monetary terms. For example, a conflict between the marketing manager and sales manager cannot be recorded in the books of accounts due to its non-monetary nature, but it will certainly affect the functioning of the activities adversely and consequently, the profits may suffer.

    Historical:

    Financial statements are historical as they record past events and facts. Due to continuous changes in the demand of the product, policies of the firm or government, etc, analysis based on past information does not serve any useful purpose and gives the only post­mortem report.

    Price Level Changes:

    Figures contained in financial statements do not show the effects of changes in the price level, i.e. price index in one year may differ from the price index in other years. As a result, the misleading picture may be obtained by making a comparison of figures of the past year with current year figures.

    Subjectivity & Personal Bias:

    Conclusions drawn from the analysis of figures given in financial statements depend upon the personal ability and knowledge of an analyst. For example, the term ‘Net profit’ may be interpreted by an analyst as net profit before tax, while another analyst may take it as net profit after tax.

    Lack of Regular Data/Information:

    Analysis of financial statements of a single year has limited uses. The analysis assumes importance only when compared with financial statements, relating to different years or different firm.

    Financial statements are the means of conveying to management, owners and interested outsiders a concise picture of profitability and financial position of the business. The preparation of the final accounts is not the first step in the accounting process but they are the end products of the accounting process which give concise accounting information of the accounting period after the accounting period is over. To know the profit or loss earned by a firm, Trading, and Profit and Loss Account is prepared. Balance Sheet will portray the financial condition of the firm on a particular date.

    Explanation of Financial Statements Objectives Importance and Limitations ilearnlot
    Explanation of Financial Statements: Objectives, Importance, and Limitations, Image Credit from ilearnlot.com.
  • Value Added Statements: Definition, Advantages, and Disadvantages!

    Value Added Statements: Definition, Advantages, and Disadvantages!

    Learn, Explain Value Added Statements: Definition, Advantages, and Disadvantages! 

    The main thrust of financial accounting development in the recent decades has been in the area of `how’ we measure income rather than `whose’ income we measure. The Concept of Value Added Statements: Meaning of Value Added Statements, Definition of Value Added Statements, Advantages of Value Added Statements, and Limitations or Disadvantages of Value Added Statements! The common belief of the traditional accountants that profit is a reward of the proprietors has been considered as a very narrow definition of income. This was so because previously the assets were assumed to be owned by the proprietor and liabilities were thought as proprietor’s obligations. Also learned, Guide to Theories in Human Resource Management! Value Added Statements: Definition, Advantages, and Disadvantages!

    This notion of proprietorship was accepted and practiced so as long as the nature of business did not experience revolutionary changes. However, with the emergence of corporate entities and the legal recognition of the existence of business entities separate from the personal affairs and interest of the owners led to the rejection of the proprietary theory.

    Definition: The financial statement which shows how much value (wealth) has been created by an enterprise through utilization of its capacity, capital, manpower, and other resources, and how it is allocated among different stakeholders (employees, lenders, shareholders, government, etc.) in an accounting period.

    Value added is now reported in the financial statements of companies in the form of a statement. Value Added Statement (VAS) is aimed at supplementing a new dimension to the existing system of corporate financial accounting and reporting. This is called value-added statement. This statement shows the value created; value added (value generated) and the distribution of it to interest groups viz. Employees, shareholders, promoters of capital and government. 

    Since VAS represents how the value or wealth created or generated by an entity is shared among different stakeholders, it is significant from the national point of view. ICAI, 1985 has defined Value Added Statement as a statement that reveals the value added by an enterprise which it has been able to generate, and its distribution among those contributing to its generation known as stakeholders.

    For the purpose of calculating the amount of value added and its distribution, the value added statement is prepared. The main concern of this statement lies in deriving a measure of wealth (i.e. value), the entity has contributed to the society through the collective efforts of the various stakeholders. This statement is prepared and published voluntarily with the annual financial reports. Thus the presentation of a statement of value-added aids in the disclosure of VA by an enterprise.

    The value-added statement may be defined as a statement, which shows the income of the company as an entity and how that is divided between the people who have contributed to its creation.

    Assumptions in Value Added Statements:

    Following are the basic assumptions which are used for computation of value-added income through the preparation of value-added statements.

    • VAS is a supplement, not a substitute to P&L account.
    • The same data which is recorded and processed by the conventional accounting system is used in the preparation of VAS.
    • The basic accounting concepts and principals of accounting remain the same in preparation of VAS.

    It is convenient to prepare Value Added statements from conventional Profit & Loss account. However, there is a lot of difference between these two statements since the income statements contain certain nonvalue-added items e.g. provisions, interests, non-trading profit, and losses, etc.

    Objectives of Value Added Statements:

    The main objectives of preparing Value Added Statements are:

    • To indicate the value or wealth created by an enterprise. In a way, it shows the wealth-creating ability of the organization.
    • To show the manner in which the wealth created is distributed amongst the employees, shareholders and the government. The pattern of distribution of value added can be clearly understood.
    • To indicate the organization’s contribution to national income.
    • To use it as a basis for making inter-firm and intra-firm analysis, for preparation of financial plans and targets, for developing productivity linked incentive schemes.

    Value Added Statements v/s Profit & Loss Account:

    The traditional Profit & Loss Account is prepared on the theory that the company was created by its shareholders and exists for their benefit. However, the traditional accounting system shows only the profits or losses made by a business enterprise and do not provide any information showing the extent to which the wealth is created by a business unit in a given period. 

    The newly developed accounting method of value added is aiming to add a new dimension to the existing system of corporate financial accounting and reporting through the disclosure of additional information regarding the amount of wealth an entity has created in an accounting period and how it has been divided up by the entity amongst those who have contributed to its creation.

    The statement of value-added conceives the company as the corporate entity in which those who provide capital and those who provide labor cooperate to create wealth which they share amongst themselves and with the government. When the value added statement is prepared, then the company is viewed as a `wealth’ producing entity of a number of groups which are known as stockholders. 

    The value-added statement shows the wealth obtained by its employees, government, providers of capital or business itself during a period of time and the manner in which the generated value is distributed among the employees, government and the providers of capital. It shows the companies contributing to the national income.

    The value-added statement is not a substitute, but a supplement to the Profit & Loss Account although it is based on the figures from the latter. The value-added statement is essentially a much simpler statement than the profit statement. The Profit & Loss Account is prepared on the basis of double entry system and its preparation is statutorily compulsory, but the value added statement is not prepared in the statutory account.

    Advantages of Value Added Statements:

    The following are some of the advantages of Value Added Statements:

    • Reporting on VA improves the attitude of employees towards their employing companies. This is because the VA statement reflects a broader view of the companies objectives and responsibilities
    • VA statement makes it easier for the company to introduce a productivity linked bonus scheme for employees based in VA. The employees may be given productivity bonus on the basis of VA/payroll ratio
    • VA based (e.g. VA/Payroll, taxation/VA, VA/sales, etc.) are useful diagnostic and predictive tools. Trends in VA ratios comparisons with other companies and international comparisons may be useful.
    • VA provides a very good measure of the size and importance of a company. To use sales figures or capital employed figures as a basis for company ranking can cause distortion. This is because sales may be inflated by large bought-in expenses or a capital-intensive company with a few employees may appear to be more important than a highly skilled labor intensive company
    • VA statement links a company’s financial accounts to national income. A company’s VA indicates the company’s contribution to national income.
    • Finally, VA statement is built on the basic conceptual foundation which is currently accepted on the balance sheet and income statements. Concepts such as going concern, matching, consistency, and substance over form are equally applicable to the VA statement.

    Criticisms and Limitations or disadvantages of Value Added Statements:

    It is argued that although the Value Added statements shows the application of VA to several interest groups (like employees, government, shareholders, etc.), the risk associated with the company is only borne by the shareholders. In other words, employees, government, and outside financers are only interested in getting their share in VA, but, when the company is in trouble the entire risk associated therein is borne only by shareholders. Therefore, the concept of showing value added as applied to several interested groups is being questioned by many academics. 

    They advocated that since the shareholders are ultimate risk-takers, the residual profit remaining after meeting the obligation of outside interest group should only be shown as value added accruing to the shareholders. However, academics have also admitted that from the overall point of view value-added statement may be shown as the supplementary statement of financial information. But in no case can the VA statement substitute the traditional income statement (i.e. Profit and loss account).

    Another contemporary criticism of VA statement is that such statements are non-standardized. However, this practice of non-standardization can be effectively eliminated by bringing out an accounting standard on value added. Therefore, this criticism is a temporary phenomenon.

    Thus, along with the advantages, the value added statements embody certain limitations also. These limitations are as follows:

    • Preparation and presentation of the value-added statement may lead to information overload and confusion, as an ordinary employee reading his company’s corporate annual report may not be able to reconcile the value added statement with the earnings statement.
    • Another limitation of Value-added statement is that it raises a danger that management may take the maximization of value added as their goal i.e. the inclusion of the value added may wrongly lead management to pursue maximization of firms value.
    • Another argument against a value-added statement is that its inclusion in the corporate annual report would involve extra work, therefore, extra costs and delay and also a slight loss of confidentiality in view of the additional disclosure involved.
    • The most severe limitation of value-added data emerges from lack of any uniformity and consistency amongst different companies in the preparation and presentation of Value Added statements. VAS is flagrantly standardized.
    • Since there are various methods of calculating VA, it is difficult to make inter-firm comparisons. An even intra-firm comparison is not possible if the treatment of these items is changed in the subsequent years.
    • Value Added statements may lead to confusion especially in the cases where wealth or value added is increasing while earnings are decreasing.

    In spite of these limitations, it may be said that the value-added statement brings about certain changes in emphasis rather than the change in the content in the traditional financial statement. Thus it is considered as a valuable means of social disclosure.

    Value Added Statements Definition Advantages and Disadvantages - ilearnlot

  • What is the Financial Statement Analysis?

    Learn, Explain What is the 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 be considered 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 interested in EPS, dividend, net worth and market value per share. Also learned, Concept of Accountability in Financial Management, What is the Financial Statement Analysis?

    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. Government is interested 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 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. 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. Financial Analysis is the process of determining the significant operating and financial characteristics of a firm from accounting data and financial statement. 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 intended 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 financial statements provide the summary of accounts 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 financial statement is to convey an understanding of some financial aspects of the company.

    Financial statement analysis involves appraising the financial statement and related footnotes of an entity. This may be done 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 is done to obtain a better insight into a firm’s position and performance. Analyzing a financial statement is a process of evaluating the relationship between component 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 done to evaluate the performance of the company. 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 is known 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 in order to appraise financial performance.

    Ratio analysis is such a powerful tool of financial analysis that through it, the economic and financial position of a business unit can be fully x-rayed. Ratios are just a convenient way to summarize large 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 a period of time. Performance ratio can provide an 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 being evaluated. Short-term creditors are concerned 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 interested in liquidity. Long-term creditors hold bonds or debentures; mortgages against the firm are interested in 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 the 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 for 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. 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 percentage relationship that each item bears to the same item in the base year. Trend percentage discloses the changes in the financial and operating data between specific periods and makes it possible to form an opinion as to whether favorable and unfavorable tendencies are reflected by the data.

    Comparative Statement Analysis is another method of measuring the performance of the company. It is used 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 which can then be addressed to rectify the situation.

  • Components of a Strategy Statement

    Components of a Strategy Statement

    What are Components of a Strategy Statement?

    The strategy statement of a firm sets the firm’s long-term strategic direction and broad policy directions. It gives the firm a clear sense of direction and a blueprint for the firm’s activities for the upcoming years. The main constituents of a strategic statement are as follows:

    Strategic Intent

    An organization’s strategic intent is the purpose that it exists and why it will continue to exist, providing it maintains a competitive advantage. Strategic intent gives a picture of what an organization must get into immediately in order to achieve the company’s vision. It motivates the people. It clarifies the vision of the vision of the company.

    Strategic intent helps management to emphasize and concentrate on the priorities. Strategic intent is, nothing but, the influencing of an organization’s resource potential and core competencies to achieve what at first may seem to be unachievable goals in the competitive environment. A well expressed strategic intent should guide/steer the development of strategic intent or the setting of goals and objectives that require that all of the organization’s competencies be controlled to a maximum value.

    Strategic intent includes directing organization’s attention on the need of winning; inspiring people by telling them that the targets are valuable; encouraging individual and team participation as well as the contribution, and utilizing intent to direct allocation of resources.

    Strategic intent differs from strategic fit in a way that while strategic fit deals with harmonizing available resources and potentials to the external environment, strategic intent emphasizes on building new resources and potentials so as to create and exploit future opportunities.

    Vision Statement

    A vision statement identifies where the organization wants or intends to be in future or where it should be to best meet the needs of the stakeholders. It describes dreams and aspirations for future. For instance, Microsoft’s vision is “to empower people through great software, any time, any place, or any device.” Wal-Mart’s vision is to become the worldwide leader in retailing.

    A vision is the potential to view things ahead of themselves. It answers the question “where we want to be”. It gives us a reminder about what we attempt to develop. A vision statement is for the organization and its members, unlike the mission statement which is for the customers/clients. It contributes to effective decision-making as well as effective business planning. It incorporates a shared understanding about the nature and aim of the organization and utilizes this understanding to direct and guide the organization towards a better purpose. It describes that on achieving the mission, how the organizational future would appear to be.

    Mission Statement

    The mission statement is the statement of the role by which an organization intends to serve its stakeholders. It describes why an organization is operating and thus provides a framework within which strategies are formulated. It describes what the organization does (i.e., present capabilities), who all it serves (i.e., stakeholders) and what makes an organization unique (i.e., the reason for existence).

    A mission statement differentiates an organization from others by explaining its broad scope of activities, its products, and technologies it uses to achieve its goals and objectives. It talks about an organization’s present (i.e., “about where we are”). For instance, Microsoft’s mission is to help people and businesses throughout the world to realize their full potential. Wal-Mart’s mission is “To give ordinary folk the chance to buy the same thing as rich people.” Mission statements always exist at the top level of an organization, but may also be made at various organizational levels. Chief executive plays a significant role in the formulation of a mission statement. Once the mission statement is formulated, it serves the organization in long run, but it may become ambiguous with organizational growth and innovations.

    In today’s dynamic and competitive environment, the mission may need to be redefined. However, care must be taken that the redefined mission statement should have original fundamentals/components. The mission statement has three main components a statement of mission or vision of the company, a statement of the core values that shape the acts and behavior of the employees, and a statement of the goals and objectives.

    Goals and Objectives

    A goal is a desired future state or objective that an organization tries to achieve. Goals specify in particular what must be done if an organization is to attain mission or vision. Goals make the mission more prominent and concrete. They coordinate and integrate various functional and departmental areas in an organization.

    Objectives: Objective, in general, indicates a place where you want to reach. In organizational literature, it means the aim which an organization tries to achieve. Objectives are generally in plural form. Objectives are predetermined; they provide clear direction to the activities and results to be obtained from the planning process. Objectives must be SMART (Specific, measurable, achievable, realistic and timely). Objectives must be clearly defined so that the works become goal-oriented and the unproductive and unsystematic tasks can be avoided.

    Goals: A Goal is simply something that somebody wants to achieve. The synonyms of goal are aim, ambition, purpose, target and objective. Simply speaking, goal refers to the purpose towards which the efforts are made or endeavors are directed. A goal has a time-frame which is generally long term. So, it’s a long term plan.

    At this stage, it is important to differentiate between the terms objective and goal, because the words, objective and goals seem to be synonymous, but, in fact, they are not. It does not matter much which word you call goal and which word you call objective if you are consistent in your own use and understand its relevance or applicability. However, if there are words in English that are confusing, especially to the students, objective and goal are the ones among them. It’s, therefore, important to understand them so as to avoid the confusion.

    When you have something you want to accomplish, it is important to set both goals and objectives. Once you learn the difference between goals and objectives, you will realize that how important it is that you have both of them. Goals without objectives can never be accomplished while objectives without goals will never get you to where you want to be. The two concepts are separate but related and will help you to be who you want to be.

  • Advantage and Disadvantages of Mission Statement

    Advantage and Disadvantages of Mission Statement

    Difference of Advantage and Disadvantages of Mission Statement

    What is Definition of Mission Statement? A sentence describing a company’s function, markets and competitive advantages; a short written statement of your business goals and philosophies. Difference of Advantages and Disadvantages of Diversity Management.

    A mission-statement defines what an organization is, why it exists, its reason for being. At a minimum, your mission-statement should define who your primary customers are, identify the products and services you produce, and describe the geographical location in which you operate.

    If you don’t have a mission-statement, create one by writing down in one sentence what the purpose of your business is. Ask two or three of the key people in your company to do the same thing. Then discuss the statements and come up with one sentence everyone agrees with. Once you have finalized your mission-statement, communicate it to everyone in the company.

    It’s more important to communicate the mission-statement to employees than to customers. Your mission-statement doesn’t have to be clever or catchy just accurate.

    If you already have a mission-statement, you will need to periodically review and possibly revise it to make sure it accurately reflects your goals as your company and the business and economic climates evolve. To do this, simply ask yourself if the statement still correctly describes what you’re doing.

    If your review results in a revision of the statement, be sure everyone in the company is aware of the change. Make a big deal out of it. After all, a change in your mission probably means your company is growing-and that’s a big deal.

    Once you have designed a niche for your business, you’re ready to create a mission-statement. A key tool that can be as important as your business plan, a mission-statement captures, in a few succinct sentences, the essence of your business’s goals and the philosophies underlying them. Equally important, the mission-statement signals what your business is all about to your customers, employees, suppliers and the community.

    The mission-statement reflects every facet of your business: the range and nature of the products you offer, pricing, quality, service, marketplace position, growth potential, use of technology, and your relationships with your customers, employees, suppliers, competitors and the community. Components of a Strategy Statement.

    Advantages of Mission-Statement

    Provides direction: Mission-statements are a way to direct a business into the right path, it plays a part in helping the business make better decisions which can be beneficial to them. Without the mission-statement providing direction, businesses may struggle when it comes to making decisions and planning for the future, this is why providing direction could be considered one of the most advantageous points of a mission-statement.

    Clear purpose: Having a clear purpose can remove any potential ambiguities that can surround the existence of a business. People who are interested in the progression of the business, such as stakeholders, will want to know that the business is making the right choices and progressing more towards achieving their goals, which will help to remove any doubt the stakeholders may have in the business.

    The benefit of having a simple and clear mission-statement is that it can be beneficial in many different ways. A mission-statement can help to play as a motivational tool within an organization. It can allow employees to all work towards one common goal that benefits both the organization and themselves. This can help with factors such as employee satisfaction and productivity. It is important that employees feel a sense of purpose. By giving them this sense of purpose it will allow them to focus more on their daily tasks. Help them to realize the goals of the organization and their role.

    Disadvantages of Mission-Statement

    Although it is mostly beneficial for a business to craft a good mission-statement. There are some situations where a mission-statement can be considered pointless or not useful to a business.

    Unrealistic: In most cases, mission statements turn out to be unrealistic and far too optimistic. An unrealistic mission statement can also affect the performance and morale of the employees within the workplace. This is because an unrealistic mission statement would reduce the likelihood of employees being able to meet this standard which could demotivate employees in the long term. Unrealistic mission statements also serve no purpose and can consider a waste of management’s time. Another issue which could arise from an unrealistic mission statement is that poor decisions could made in an attempt to achieve this goal. Which has the potential to harm the business and seen as a waste of both time and resources.

    Waste of time and resources: Mission-statements require planning, this takes time. Effort for those who are responsible for creating the mission statement. If the mission-statement is not achieve, then the process of creating. The mission-statement could seen as a waste of time for all of the people involve. A lot of thought and time is spent in designing a good mission-statement. And to have all of that time wasted is not what businesses can afford to doing. The wasted time could have spent on much more important tasks within the organization such as decision-making for the business.

    Advantage and Disadvantages of Mission Statement

  • Mission Statement

    Mission Statement

    What is Mission Statement?

    A mission statement is a short statement of an organization’s purpose, identifying the scope of its operations: what kind of product or service it provides, its primary customers or market, and its geographical region of operation. It may include a short statement of such fundamental matters as the organization’s values or philosophies, a business’s main competitive advantages, or a desired future state the “vision”.

    A mission statement is not simply a description of an organization by an external party, but an expression, made by its leaders, of their desires and intent for the organization. The purpose of a mission statement is to focus and direct the organization itself. It communicates primarily to the people who make up the organization its members or employees giving them a shared understanding of the organization’s intended direction. Organizations normally do not change their mission statements over time, since they define their continuous, ongoing purpose and focus.

    According to Chris Bart, professor of strategy and governance at McMaster University, a commercial mission statement consists of three essential components:

    Key Market: Who is your target client or customer (generalize if needed)?

    Contribution: What product or service do you provide to that client?

    Distinction: What makes your product or service unique, so that the client would choose you?

    Bart estimates that in practice, only about ten percent of mission statements say something meaningful. For this reason, they are widely regarded with contempt.

    The next step is to prepare mission statements. If the vision is “WHAT” of life, then the mission is “WHY” and “HOW”. It identifies the roles and activities to which an individual is committed and provides the overall direction for achieving the vision. Mission focuses on what you want to be and what you want to do- contributions and achievements. Mission focuses on the values and principles upon which being and doing are based. A personal vision needs to be clearly developed so that the mission statement can be based on it.

    I. These statements should clearly indicate the important roles and methodologies followed for fulfilling the vision.

    II. Techniques and tools such as affinity diagram, brainstorming, fish-bone diagram, and surveys should be used.

    III. Mission statements should realize the vision in action. Conduct a mind map to check whether it is really fulfilled.

    IV. These statements will carry the information which needs to be fulfilled in the near future.

    V. Time factor may be brought in to make it more systematic.

    Mission statements are prepared to make the employees understand in clear terms “HOW” to achieve the vision and “WHY” all this has to be done. It is a ROAD MAP for achieving the vision. The mission statements act as a guiding force encouraging the individuals to work towards reaching the vision.

    What is Purpose of Mission statement?

    The sole purpose of a mission statement is to serve as your company’s goal/agenda, it outlines clearly what the goal of the company is. Some generic examples of mission statements would be, “To provide the best service possible within the banking sector for our customers.” or “To provide the best experience for all of our customers.” The reason why businesses make use of mission statements is to make it clear what they look to achieve as an organization, not only for themselves and their employees but to the customers and other people who are a part of the business, such as shareholders. As a company evolves, so will their mission statement, this is to make sure that the company remains on track and to ensure that the mission statement does not lose its touch and become boring or stale.

    North American magazine and website that carries news stories about entrepreneurship, small business management, and business, Entrepreneur explains the purpose of a mission statement as the following:

    “The mission statement reflects every facet of your business: the range and nature of the products you offer, pricing, quality, service, marketplace position, growth potential, use of technology, and your relationships with your customers, employees, suppliers, competitors and the community.”

    It is important that a mission statement is not confused with a vision statement. As discussed earlier, the main purpose of a mission statement is to get across the ambitions of an organization in a short and simple fashion, it is not necessary to go into detail for the mission statement which is evident in examples given. The reason why it is important that a mission statement and vision statement are not confused is because they both serve different purposes. Vision statements tend to be more related to strategic planning and lean more towards discussing where a company aims to be in the future.

    Here are what business leaders say a mission statement should do for a company:

    “A good vision or mission statement will fill a few roles: It will be toothy enough to engage the media, analysts and other industry watchers. It will be aspirational enough to give employees something to reach for and bind them together in their day-to-day work. And it will be clear and specific enough to build the brand and affect public perception of the company. In an ideal world, it will even give your customers a sense that they’re buying into your vision when they purchase one of your products.” by Kyle Monson, a partner at Knock Twice hybrid creative agency.

    “A company’s mission statement is the cornerstone on which it is built. Its strategic plan and its culture are directly tied to the vision the mission statement puts forth. It is important that a mission statement supports the overarching goals and purpose of the company and explain why you exist as a business in a way that can be understood internally within the company and externally to consumers.” by Gerry David, president, and CEO of healthy lifestyle company Celsius Holdings.

    “Creating a mission statement takes time and a lot of decision making. It lays down expectations for how your customers and employees will interact with one another, so take your time with it. Clearly, write down your vision of the company and ask yourself, ‘What am I trying to accomplish?’ Think about how you want others to perceive your company, what’s important to you and your organization, and then prioritize it. Most importantly, make sure it’s clear, concise and easy for anyone to understand.” by Bobby Harris, president, and CEO of Blue Grace Logistics.