Overview of Financial Statements(I need help explaining the follow.pdf
- 1. Overview of Financial Statements (I need help explaining the following and/or demonstrating it for my upcoming exam if anyone could help me comprehend the concepts I would greatly appreciate it!!) Describe and interpret the balance sheet, income statement, and statement of stockholder’s equity Describe the relationship between current assets and current liabilities Describe the difference between interest-bearing and non-interest-bearing liabilities Explain the components of change on a statement of stockholder’s equity Solution Answer 1: Balance Sheet: Balance sheet is a financial statement that summarizes a company's assets, liabilities and shareholders' equity at a specific point in time. It is a Position Statement which give investors an idea as to what the company owns and owes as well as the amount invested by shareholders. The balance sheet adheres to the following formula: Assets = Liabilities + Shareholders' Equity Interpreting a Balance Sheet The balance sheet is a snapshot, representing the state of a company's finances at a moment in time. By itself, it cannot give a sense of the trends that are playing out over a longer period. For this reason, the balance sheet should be compared with those of previous periods. A number of ratios can be derived from the balance sheet, helping investors get a sense of how healthy a company is. These include the debt-to-equity ratio and the acid-test ratio, along with many others. Income Statement: An income statement also known as the "profit and loss statement" or "statement of revenue and expense" is a financial statement that measures a company's financial performance over a specific accounting period. Financial performance is assessed by giving a summary of how the business incurs its revenues and expenses through both operating and non-operating activities. It also shows the net profit or loss incurred over a specific accounting period, typically over a fiscal quarter or year. Interpreting Income Statement The income statement is divided into two parts: the operating and non-operating sections. The portion of the income statement that deals with operating items is interesting to investors and analysts alike because this section discloses information about revenues and expenses that are a direct result of the regular business operations. The non-operating items section discloses
- 2. revenue and expense information about activities that are not tied directly to a company's regular operations. Stateent of Stockholders' equity Stockholders' equity is the money attributable to a business' owners, often referred to as shareholders. It is also known as "net assets," since it is equivalent to the total assets of a company minus its liabilities, that is, the debt it owes to non-shareholders. The statement of shareholders' equity details the changes within the equity section of the balance sheet over a designated period of time. In other words, the statement of stockholder's equity is a basic reconciliation of how the ending equity is calculated. The report provides additional information to readers of the financial statements regarding equity-related activity during a reporting period. The report is typically set up in a grid pattern, with the beginning balance in each element of equity stated across the top, additions to and subtractions from the beginning balances in the middle of the report, and ending balances at the bottom that incorporate the additions and subtractions. The same format should be used in all subsequent periods, to provide reporting consistency. Interpreting Statement of Stockholder’s Equity The beginning equity is reported followed by any new investments made from shareholders along with net income for the year. Thereafter, all dividends and net losses are subtracted from the equity balance leading to ending equity balance for the accounting period. Since net income is needed to calculate the ending equity balance for the year, therefore the statement of equity must be prepared after the income statement. Answer 2: Current assets can be defined as an asset on the balance sheet which is expected to be sold or otherwise used up in the near future, usually within one year or one operating cycle – whichever is longer. Current assets include cash, accounts receivable, inventory, marketable securities, prepaid expenses and other liquid assets that can be readily converted to cash. Current assets are important to businesses because they are the assets that are used to fund day-to-day operations and pay ongoing expenses. Current liabilities can be defined as those liabilities that are to be paid or settled in cash within a year. Examples of current liability are accounts payable for goods, outstanding expenses etc. Relationship between Current assets and current liabilities: The difference between current asset and current liability is known as working capital which represents operating liquidity available to business. Positive working capital is required to make sure that a company is capable to carry on its business and has adequate funds to satisfy both maturing short-term debt and future operational expenses. The working capital ratio is a very basic metric of liquidity. It is intended to indicate how
- 3. capable a company is of meeting its current financial obligations and is a measure of a company's basic financial solvency. The ratio is calculated by dividing current assets by current liabilities. In reference to financial statements, it is the figure that appears on the bottom line of a company's balance sheet. It is also referred to as the current ratio. Generally, a working capital ratio of less than 1 is taken as indicative of potential future liquidity problems, while a ratio of 1.5 to 2.0 is interpreted as indicating a company on solid financial ground in terms of liquidity. An increasingly higher ratio above 2 is not necessarily considered to be better; a substantially higher ratio can indicate that a company is not doing a good job of employing its assets to generate maximum possible revenue. A disproportionately high working capital ratio is reflected in an unfavorable return on assets ratio (ROA), one of the primary profitability ratios used to evaluate companies. Answer 4: Components of change on a statement of stockholder’s equity: Typically, a statement of shareholders equity summaries changes in the following equity components: There may also be a separate column listing the number of shares of common stock at the beginning of the period, any adjustments to that number during the period, and the number of shares of common stock at the end of the period. The approach may apply to separate additional columns for other classes of preferred stock. There will be grand total figures at the top and bottom of the matrix for the total amount of beginning and ending shareholders' equity. Alternatively, the statement could present a single column of numbers, beginning with the total shareholders' equity (from all sources) at the top, then adjusting for any changes during the period, and ending with the total shareholders' equity (from all sources) at the bottom.