Analyses of financial statement’s
The two major financial statements are the balance sheet and the income statement.
In hospitality operations, balance sheets are normally prepared for an overall operation, and income statements are prepared by each of the subordinate operating departments or divisions. (Jagels, M.J., 2007)
The balance sheet
The balance sheet is a financial statement that summarizes a company’s assets, liabilities and shareholder’s equity at a specific point of 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 shareholder’s. The balance sheet is one of the most important pieces of financial information issued by a company. (Meigs&Meigs)
When looking at a company's current assets, you need to pay special attention to inventory. Inventory consists of merchandise a business owns but has not sold. It is classified as a current assets because investors assume that inventory can be sold in the near future, turning it into cash.
When analyzing a balance sheet, we also need to look at the percentage of current assets inventory represents. For example, if 70% of a company's current assets are tied up in inventory and the business does not have a relatively low turn rate, it may be a signal that something is seriously wrong and an inventory write-down is unavoidable. (Investopedia, Balance sheet, 2009)
Companies who have excellent inventory handling systems so they only order products when they are needed - they never buy too much or too little of something. Businesses that have too much inventory sitting on the shelves or in a warehouse are not being as productive as they could be: had management been wiser, the money could have been kept as cash and used for something more productive.
Current liabilities are the debts a company owes which must be paid within one year. They are the opposite of current assets. Current liabilities includes things such as short term loans, accounts payable, dividends and interest payable, bonds payable, consumer deposits, and reserves for Federal taxes.
The most important part of a balance sheet is a company's working capital (or "current") position. It tells what would be left if a company raised all of its short term resources, and used them to pay off its short term liabilities. The more working capital, the less financial strain a company experiences. By analyzing a company's position, you can clearly see if it has the resources necessary to expand internally or if it will have to turn to a bank and take on debt. One of the main advantages of looking at the working capital position is being able to foresee any financial difficulties that may arise.(About.com, Investing Lesson 3, 2009)
The purpose of the balance sheet is to provide at a specific point in time a picture of the financial conditions of a business entity relative to its assets, liabilities, and ownership equity, and also the balance sheet shows the financial position of a given business entity at a specific date. By category, each individual account, by name and its numerical balance, is shown at the end of a specific date, which is normally the ending date of an operating period.
The income statement
An income statement is a one-page financial statement which summarizes the profitability of the business entity over a specified period of time. The income statement shows how much revenue and profit a company has generated over a certain period. It also shows the net profit of loss incurred over a specific financial period, typically over a fiscal quarter or a year. Neither statement is better than the other – rather the financial statements are build to be used together to present a complete picture of a company’s finances (Investopedia, Balance sheet, 2009).
The purpose of the income statement is to show economic results of profit – motivated operations of a business over a specific operating period. The basic balance sheet and income statement cannot in themselves answer questions regarding cash inflows and cash outflows that have occurred during an operating period.
Cash flow statement
In , a cash flow statement or statement of cash flows is a that shows a company's flow of cash. The coming into the business is called cash inflow, and going out from the business is called cash outflow. The statement shows how changes in and affect , and breaks the analysis down to operating, investing, and financing activities. As an analytical tool, the statement of cash flows is useful in determining the short-term viability of a company, particularly its ability to pay bills. (Meigs&Meigs)
The primary purpose of the statement of cash flow (SCF) is to identify and report the effects of cash receipts and cash disbursements for three specific areas of business activities. This information should help investors and creditors assess an entity’s ability to generate positive future net cash flows and to meet its current and long- term obligations, including positive future dividend payments. In addition the statement of cash flows should help users assess the reasons for the differences between net income and the related cash receipts and payments. Finally, the statement of cash flows should help to determine the effects of both cash and noncash investing and financing transactions on an entity’s financial position.
A statement of cash flows explains the changes during the period in cash and cash equivalents – short – term, highly liquid investments that can be converted easily into cash. To qualify as a cash equivalent, an item mast be:
- Readily converted to cash, and
- So near its maturity that there is insignificant risk of changes in value due to changes in interest rates. (Smith, J.M., and Skousen, K.F., 1992)
In a hospitality operation, it is possible for an operation to have positive net income and, at the same time, produce a negative cash flow, or to show a net loss and have a positive cash flow. The operation section of a statement of cash flow adjusts and reconciles and accrual net income or net loss for an operating period to the net cash flow from operations. It is the change in the cash account which is identified when net cash flow, either positive or negative, is equal to the change in the cash account and the actual cash on hand at the end of the period is confirmed. (Jagels, M.J., 2007)
The statement of Owner’s Equity
The statement of owner's equity is prepared after the income statement. It shows the beginning and ending owner's equity balances and the items affecting owner's equity during the period. These items include investments, the net income or loss from the income statement, and withdrawals. Because the specific revenue and expense categories that determine net income or loss appear on the income statement, the statement of owner's equity shows only the total net income or loss. Balances enclosed by parentheses are subtracted from unenclosed balances. (Meigs&Meigs)This statement shows the paid-in capital invested in the business in exchange for stock, as of the beginning of the accounting period. It also shows how the income shown on the Income Statement was paid out as dividends, or plowed back into the business as retained earnings. (Small Business guide, Statement of Changes in Equity, 2009)
Most “outside” decisions makers use financial statements in making investment decisions – that is, selecting those companies in which they will invest resources or to which they will extend credit. Two factors of concern to creditors and investors are the solvency and profitability of a business organizations. Investors as well as creditors interested in the solvency of a business organization, but they are even more interested in its profitability. (Meigs&Meigs)
Conclusion
It is necessary to understand and analyze the financial statements of the company to see the financial situation: liquidity, current assets, liabilities, equity. Also, financial statements show efficiency of the business and profitability or loss.The managers of the companies should keep a database of a company’s financial statements for the last five years and, separately, the last 12 quarters. Include the Cash Flow Statement, Balance Sheet, and Income Statement.
By reviewing trends in the financial statements, you will have a broader understanding of the company’s:
- Financial health
- Profitability
- Cash balance and cash flow generation
- Debt levels
- Asset financing
With this spreadsheet, you can then easily add calculations, determine ratios, and develop a benchmark of the company’s performance and financial condition against its competitors. Maintain a separate spreadsheet for each company analyzed. Doing so will build a better picture of the company and its historical performance.
References
About.com, Investing lesson 3, 2009 [on-line] Available from: (Access 15 January 2009)
Investopedia, Balance sheet, 2009 [on-line] Available from: (Access 14 January 2009)
Jagels, M.J., Hospitality Management Accounting, 9th edition, 2007, USA
Meigs&Meigs, Accounting The Basic for Business Decisions, 9th editions, USA
Smith, J.M., and Skousen. K. F., Intermediate Accounting, 11th edition, 1992, South-Western Publishing Co., Cincinnati, Ohio, USA.
