3 Financial Statements - Key Reports for Decision-making | maijson GKB.

 

Financial Statements are a written records that depict a company's business operations and financial performance are called financial statements. They are typically audited to make sure they are accurate for investing, financing, or tax purposes.

Key Financial Statements:

We will explain how to comprehend financial statements and use this knowledge to better understand in order to make informed decisions, regardless of whether you are an individual or a business owner.  

Let's discuss each of these financials in more detail:

1. Balance Sheet: One of the three main financial statements that businesses and individuals use to comprehend their financial situation at a given moment in time is the balance sheet. The Statement of Financial Position is another name for it. It offers a momentary view of the equity, liabilities, and assets of an entity.

Below are the key components of Balance Sheet:

Assets: These are the financial assets that the organization owns or controls; they can be either intangible (such as patents or trademarks) or tangible (such as cash, inventory, or real estate).

Liabilities: These stand for commitments or debts that the organization owes to outside parties. Loans, accounts payable, and other monetary commitments are examples of liabilities.

Equity: Alternatively referred to as net assets or shareholders' equity, this is the remaining stake in the company's assets following the deduction of liabilities. Retained earnings, common stock, and other elements are included.

2. Income Statement: One of the three primary financial statements that companies and individuals use to evaluate their financial performance over a given time period is the Income Statement, sometimes referred to as the Profit and Loss Statement (P&L).

Below are the key components of an Income Statement:

Revenue: Sales revenue is the total amount of money made from the sale of products or services.

Cost of Goods Sold: The direct expenses incurred in creating the products or services that are sold are known as the cost of goods sold, or COGS. It covers expenses for labor, raw materials, and manufacturing overhead.

Gross Profit: COGS are deducted from total revenue to determine gross profit. It displays how profitable the main business operations are.

Operating Expenses: These comprise marketing, payroll, rent, utilities, and other selling, general, and administrative (SG&A) costs.

Operating Income (Operating Profit): After deducting operating expenses from gross profit, operating income is obtained. It shows the profit or loss resulting from the main operations of the business.

Other Income and Expenses: Non-operating items like interest income, interest expenses, and investment gains or losses are included in this section.

Net Income (Net Profit or Net Loss): The Income Statement's last line, or net income, shows the total profit or loss after all costs, taxes, and other deductions have been made. A net loss occurs when revenue is less than expenses.

Now, let's discuss why the Income Statement is important in decision-making:

Profitability Assessment: The Income Statement gives a comprehensive view of the profitability of a business over a given time frame. For the purpose of evaluating the company's success and financial standing, investors, creditors, and management need to know this information.

Investment Decision-Making: Before making an investment, investors assess a company's profitability and room for growth using the Income Statement. Consistent growth and positive net income are frequently signs of a strong company.

Creditworthiness: Lenders and creditors evaluate an organization's capacity to make enough money to pay off its debts and commitments by looking at its income statement. This aids in their assessment of the risk and creditworthiness of lending to the business.

Cost Management: Through an examination of the different types of expenses, management can pinpoint areas where expenses can be curtailed or minimized. This is essential for increasing overall profitability and operational efficiency.

Performance Evaluation: It is possible to compare the financial performance of various periods using the Income Statement. This supports management in recognizing patterns, evaluating the effects of business decisions, and selecting the best course of action.

Dividend Decisions: After deducting various costs and taxes, the income available for distribution to shareholders is determined by a company that pays dividends, and this amount is determined by looking at its Income Statement.

Strategic Planning: Strategic planning is aided by the knowledge obtained from the Income Statement. This data can be used by management to establish budgets, distribute resources, and create plans that will increase profitability.

3. Cash Flow Statement: An essential component of financial management is cash flow analysis, which entails analyzing the inflows and outflows of cash from a company over a given time frame. It offers perceptions into a business's capacity to raise capital, pay short-term debt, and sustain continuous operations. One of the three main financial statement, along with the Income Statement and Balance Sheet, is the Cash Flow Statement, which is used to perform cash flow analysis. An outline of the elements and importance of cash flow analysis is provided below:

Operating Activities:

Inflows: Cash received from main business activities, like sales and client collections, is referred to as an inflow.

Outflows: Cash payment made to staff, suppliers, and operating costs.

Investing Activities:

Inflows: Cash received from the sales of investments or real estate is referred to as an inflow.

Outflows: Money used for investments or asset purchases.

Financing Activities:

Inflows: Funds Obtained through loan acquisitions or the issuance of stocks.

Outflows: Money paid out as dividends, stock buybacks, or debt repayment.

Now, let's explore why the Cash Flow Statement is crucial in financial decision-making:

Liquidity Assessment: The ability of the business to pay its short-term debts is evaluated with the use of the Cash Flow Statement. It gives details on the cash flow from operating activities, which is essential for daily operations, debt servicing, and bill payment.

Investment Decisions: The Cash Flow Statement is a tool used by analysts and investors to assess a company's future investments. Stakeholders can determine the amount of capital expenditure and if the business is making strategic investments for long-term growth by looking at the investing activities section.

Debt Management: The section on financing activities aids in assessing the company's debt management practices. A company's long-term viability may be called into question if it continuously borrows money to fund its activities. On the other hand, a company's ability to repay debt suggests that its financial situation is better.

Free Cash Flow: An important indicator for investors is free cash flow, which is obtained from the cash flow statement. It is a representation of the cash flow a business has left over after capital expenses. A positive free cash flow suggests that there may be room for debt reduction, dividend payments, or additional investments.

Risk Assessment: Determining a company's financial risk is aided by knowing where its cash comes from and is used. A business that consistently generates positive cash flow is typically better positioned to handle financial difficulties and more robust to economic downturns.

KEY FINANCIAL RATIOS:

Financial ratios are quantitative measurements that provide light on a number of different areas of the performance and status of a company's finances. They are determined by utilizing the cash flow, balance sheet, and income statement financial data from an organization's financial statements. Investors, analysts, and management frequently use these ratios while making decisions. The following important financial ratios and their meanings are listed:

Liquidity Ratios:

Current Ratio: The ratio of current liabilities to current assets. It evaluates a business's capacity to meet its immediate obligations. Good short-term liquidity is indicated by a ratio larger than 1.

Quick Ratio (Acid-Test Ratio): The ratio of current liabilities to (current assets - inventory). By omitting less liquid assets like inventory, it offers a more cautious measurement of short-term liquidity.

Profitability Ratios:

Net Profit Margin: Divide net profit by total revenue. It shows the portion of income that is converted to profit. In general, higher margins are advantageous.

Return on Equity (ROE): Divided by shareholders' equity is net income. It calculates the rate of return on investment made by shareholders.       

Efficiency Ratios:

Asset Turnover: Divide revenue by the average amount of assets. It demonstrates how effectively a business generates sales using its assets.

Inventory Turnover: Productivity of items sold divided by typical stock levels. It gauges how rapidly a business sells its stock.

Solvency Ratios:

Debt-to-Equity Ratio: Divided by shareholders' equity is the total debt. It shows the percentage of debt financing a business has as opposed to equity capital.

Interest Coverage Ratio: Divided by interest expenses is earnings before interest and taxes, or EBIT. It evaluates the capacity of an organization to pay interest.

Market Ratios:

Price-to-Earnings Ratio (P/E): Divided by earnings per share is the market price per share. It represents what investors anticipate will happen to a company's earnings in the future.

Dividend Yield: Divided by the market price per share are the dividends per share. Dividends are used to illustrate the return on investment.

Growth Ratios:

Earnings Per Share (EPS): The percentage shift in EPS during a certain time frame. It shows how well the business can raise profits.

Revenue Growth: the revenue change as a percentage over a given time period. It demonstrates the business's capacity to boost sales.

Importance in Decision-Making:

Performance Evaluation: Financial ratios assist in evaluating the past and present performance of a business, enabling stakeholders to make well-informed decisions regarding its financial stability.

Benchmarking: Ratios give a foundation for evaluating a business's performance in relation to competitors or industry averages, which helps pinpoint strengths and shortcomings.

Forecasting and Planning: Ratios are useful tools for budgeting for growth or cost-cutting initiatives as well as predicting future financial performance.

Investment Decisions: Financial ratios are used by investors to assess an investment's desirability. Understanding a potential investment's risk and return profile is made easier with the use of ratios.

Creditworthiness: Ratios are used by creditors and lenders to assess a company's creditworthiness and debt servicing capacity.

Strategic Decision-Making: When deciding whether to invest in new initiatives, grow operations, or optimize cost structures, management consults financial ratios.

 

In conclusion, for anybody involved in financial decision-making, having a thorough understanding of financial statements is essential. Comprehending and evaluating these declarations enables interested parties to successfully negotiate the intricate business environment, make wise decisions, and support the long-term expansion and prosperity of a company. Financial statements are dynamic tools that direct current activities and influence future strategies, not merely historical data.