Unit III Components Of Financial Statements For Financial Analysis And Reporting Bcom Sem 3 Delhi University Study Notes

Unit III Components Of Financial Statements For Financial Analysis And Reporting Bcom Sem 3 Delhi University : The following points highlight the four main components of financial statements. The main components are 1. Balance Sheet 2. Income Statement 3. Statement of Changes in Owners’ Equity 4. Statement of Changes in Financial Position.

Financial Statements Component # 1. Balance Sheet:

The American Institute of Certified Public Accountants defines Balance Sheet as, “A tabular statement of summary of balances (debits and credits) carried forward’ after an actual and constructive closing of books of account and kept according to principles of accounting.’” The purpose of the balance sheet is to show the resources that the company has, i.e., its assets, and from where those resources come from, i.e. its liabilities and investments by owners and outsiders.

The balance sheet is one of the important statements depicting the financial strength of the concern. It shows on the one hand the properties that it utilizes and on other hand the sources of those properties. The balance sheet shows all the assets owned by the concern and all the liabilities and claims it owes to owners and outsiders. The balance sheet is prepared on a particular date.

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Unit III Components Of Financial Statements For Financial Analysis And Reporting Bcom Sem 3 Delhi University Study Notes

Unit III Components Of Financial Statements For Financial Analysis And Reporting Bcom Sem 3 Delhi University :  Financial statements are important sources of financial information that can be used to make sound business decisions. This means that every component of financial statements is important.

Components of a financial statement can be described as the building blocks used for constructing the financial statement and these items represent, in words and numbers, various resources, claims to those resources, and any transactions that create changes in those resources and claims.

Below is a list of components of the most important financial statements – balance sheet, profit and loss (P&L) statement and cash flow statement – and their importance.

Components of Important Financial Statements

1. Balance Sheet

   Balance Sheet is a statement of the assets, liabilities, and capital of an organization at one particular point in time. This statement gives an idea as to what the company owns and owes and also the amount of shareholding. The critical components of this statement are as below.

• Assets:

  An asset can be tangible or intangible and is often owned or controlled with the belief that it would provide some future benefit and can be tangible or intangible. While the former includes current assets and fixed assets, the latter refers to rights and other non physical resources that provide value to the business. Current assets consist of inventory, accounts receivables and other short term investments. Fixed assets could be buildings, equipment and other physical resources. Intangible assets usually include goodwill, copyright, trademarks and patents.

• Liabilities:

  Liabilities are a company’s legal debts or obligations that might arise during the course of business operations. These are usually settled over time through the transfer of economic benefits like cash, goods or services. Liabilities include accounts payable, salaries or wages payable, interest due, customer deposits and other such obligations to third parties. Liabilities might be of two types –  current or long term. While the former could be liquidated within a year, the latter can be repaid only in the long term (more than a year). Long-term liabilities include long-term bonds issued by the firm, notes payables, leases, pension obligations, and long-term product warranties.

• Equity or owner’s equity:

  It is the residual assets of an entity that remain after deducting liabilities.  Theoretically, this is the capital available for distribution to shareholders. Hence, from a company’s liquidation perspective, equity would be considered the residual claim on the assets of a business, available to shareholders, after liabilities have been paid. For instance, if Company X has $3,000,000 as assets and $800,000 as liabilities, then equity would be $2,200,000 (= $3,000,000 – $800,000). Equity usually comprises funds contributed by shareholders, reserves and retained earnings. Therefore, the only way to increase the amount of owners’ equity is by either getting more funds from investors or by increasing profits.

2. Profit and Loss Statement:

   This statement is a summary of the financial performance of a business over time. This is usually prepared after every quarter or year. The components in this statement include:

• Revenues:

  The amount of cash that a company actually receives during a specific period, through the sale of goods or services, is referred to as the company’s revenue. This would include discounts and deductions for returned merchandise. Revenues would also include the amount received as a result of using the capital or assets of the business as part of the operations of the business. Revenue is the “top line” or “gross income” of the business.

• Expenses:

  The outflow of money or incurring of liabilities (or a combination of both) through production of goods, rendering services, or carrying out any activity that would form a part of the business’s operations, are the expenses of the company. Typical business expenses include wages or salaries, utilities such as rent, depreciation of capital assets, and interest paid on loans. The purchase of an asset such as a building or equipment is not an expense. Expenses also include the Cost of Goods Sold (COGS), which is the cost incurred for selling goods during the period, and includes import duties, freight, handling and other costs for converting inventory to finished goods.

• Gains:

  A company’s gain is an increase in equity through peripheral or incidental transactions by a firm, other than those from revenue or investments by owners (shareholders). It refers to any economic benefit that is outside the normal operations of a business. Typically, gains refer to unusual and nonrecurring transactions, such as gain on sale of land, change in a stock’s market price or a gift. It is often shown in the P&L statement as non operating income.

• Losses:

  A company’s losses are decreases in equity through peripheral or incidental transactions carried out by the firm, other than those from expenses or distributions to owners. This could be loss on sale of an asset, writing down of assets or a loss from lawsuits. It could also include costs that give no benefit. It is often shown in the P&L statement as non-operating expense.

3. Cash Flow statement:

   This statement is a summary of the actual or anticipated inflows and outflows of cash in a firm over an accounting period. This could be prepared at the end of a month, quarter or year.  The cash flow statement would reflect the liquidity position of the business. This is used as the basis for budgeting and business-planning. The components in this statement include:

• Cash Flow from Operating Activities:

  Operating activities of a business refer to the production, sales and delivery of the finished product and collection of payment from customers. Cash outflows here could include purchasing raw materials, advertising, and cost of shipping the product.  They might not include payment to suppliers, employees and interest payments. Depreciation and amortization are also included in the cash flow statement.  Cash inflows here consist of receipt from sale of goods and services and interest received.

• Cash Flow from Investing Activities:

  These are cash flows related to investments and include purchase of assets, gains or losses through investments in the financial market or in subsidiaries, and other related items.

• Cash Flow from Financing Activities:

  This would account for activities that aid a firm in raising capital and repaying investors. The cash flow might include cash dividends, adding or changing loans or issue of stock. Cash flow from financing activities reveals the company’s financial strength.  Financing activities that produce positive cash flow include cash from issued stocks and bonds. Financing activities that produce negative cash flow include cash for repurchasing stock, paying off debt or interest or payment of dividend to shareholders.

Unit III Components Of Financial Statements For Financial Analysis And Reporting Bcom Sem 3 Delhi University Study Notes

Unit III Components Of Financial Statements For Financial Analysis And Reporting Bcom Sem 3 Delhi University :  Apart from schedules, accounting rules allow accountants to calculate certain figures based on certain assumptions – for example the company may have given a lot of goods on credit and based on past experiences, the accountant may write off certain percentage of debtors (amounts receivable from credit sales) as irrecoverable. Such assumptions made while preparing financial statements will be separately disclosed in a statement called ‘notes to accounts’.

Unit III Components Of Financial Statements For Financial Analysis And Reporting Bcom Sem 3 Delhi University : Apart from this, the independent auditor may also have his opinion about the correctness of the assumptions made and about the truth and fairness of the figures disclosed in the financial statements. He discloses his opinion and comments in a report called the audit report.

So apart from the 3 components that comprise financial statements, the following three statements also form part of it as a sub category-they are-

• Schedules to accounts ( Part of balance sheet and income statements)
• Notes to accounts. ( Accountant’s disclosure about the assumptions made)
• Audit report (Independent auditor’s comments and opinion)

So there are three components and three sub-components for any financial statement. Now we will explain in brief what those 3 statements are about.

INCOME STATEMENT

Unit III Components Of Financial Statements For Financial Analysis And Reporting Bcom Sem 3 Delhi University : The income statement summarizes a company’s sales (Also called revenues or turnover) and expenses. The final net figure is either profit (if total of revenues exceed Expenses) or loss ( if expenses exceed revenues).The ‘profit’ or ‘loss’ shown in this statement is essentially an ‘estimate’( we will tell you why, later ! )  For example – if a company reports of having made a profit of Rs 300 Crore, it doesn’t mean that it has Rs 300 Crore in it’s bank account.

BALANCE SHEET

A balance sheet summarizes a company’s assets, liabilities and shareholders’ equity at a specific point in time. These three balance sheet segments give investors an idea as to what the company owns and owes, as well as the amount invested by the shareholders.

CASH FLOW STATEMENT

‘Profit’ and ‘cash’ are not the same. A statement that shows ‘actual cash’ coming in and how the same has been used is called the cash flow statement. It deals with liquidity. Being profitable does not necessarily mean being liquid. A company can fail because of a shortage of cash, even while profitable. So to analyse the economic realities, cash flow statements are prepared.

CONCLUSION

Financial statements provide financial statistics of past events; but they are not forward looking. They don’t provide key non-financial information like quality of revenues, types of customers and risk factors. Certain qualitative elements are not considered in the financial statements terms like the quality and reputation of the management team and employees because they are incapable of being measured in monetary terms.

Unit III Components Of Financial Statements For Financial Analysis And Reporting Bcom Sem 3 Delhi University Study Notes