Analyzing Financial Statements

Abstract

This paper aims at discussing how different types of financial statements can be used in the marketplace. The paper later goes on to state and identify the different types of financial statements prepared by an entity and how it actually shows the financial position of the enterprise. With the identification of different types of financial statements attempt has been made to exploit and discover the linkages and interrelationship between them. The paper also highlights the usefulness of various accounting ratios and why are they considered important in assessing the financial health of the organization.

Abstract2

Introduction4

Discussion4

Usage of Financial Statements4

Investors and potential investors5

Financial Institutions5

Vendors6

Customers6

Rating agencies6

Components of Financial Statements7

Statement of Financial Position7

Statement of Comprehensive Income8

Statement of Changes in Equity8

Statement of Cash flows9

Notes to Financial Statements9

Financial Statement linkages10

Why are Ratios used and their importance?12

Profitability ratios13

Liquidity ratios14

Efficiency ratios15

Importance of Generally Accepted Accounting Principles (GAAP)16

Conclusion17

References18

Analyzing Financial Statements

Introduction

The statutory and international guidelines have made the preparation and publishing of financial statements mandatory for all listed entities. They have immense use for all stakeholders and play a pivotal role in informed decision making. There are several types of financial statements such as Statement of Comprehensive Income and they all reveal distinctly about the business. All financial statements are interlinked as they all complement each other in one way or another. Financial Statements are published to be analyzed and interpreted upon. Such interpretation is deemed effective when it is based on accounting ratios. Financial Statements can be prepared in accordance with the International Accounting Standards (IAS) or in accordance with Generally Accepted Accounting Principles (GAAP). Although greater convergence is on agenda, but unarguably both are important in effective preparation of Financial Statements (Chen et al, 1999).

Discussion

Usage of Financial Statements

Financial Statements is of immense use for all stakeholders especially market participants. Stakeholders or users of financial statements can be categorized as internal users and external users. In the marketplace, main stakeholders fall into the category of external users. Different stakeholders in the marketplace make use of the financial statements differently (White, 2006)

Investors and potential investors

Existing investors or shareholders use the financial statements to assess the profitability of the organization as their dividends are dependent upon it. Any rise or fall in the profitability reflected by the income statement can have a major impact on investors as they are very sensitive to it. The share price is also dependent on the profitability status of the organization. Stock brokers and stock exchange participants such as mutual investment funds also use the financial statements to advise their clients on the best performing share. Potential investors also use the financial statements to decide whether investing in the company is worthwhile. If all components of the financial statements reflect a healthier picture they might be motivated to invest. Shareholders also use the financial statements to analyze the liquidity position of the company as decision to make new investments is dependent on the cash flow position of the organization (Benjamin and Stenga, 1977).

Financial Institutions

Financial institutions such as banks and other lenders use the financial statements of ...