Many people are intimidated by financial statements but being able to read and understand them is a very useful life skill. Working in the financial services often means having access to a variety of business sectors and being able to read financial statements gives a good insight into clients and other businesses.
It is also information which can be used to evaluate and ask more specifically directed questions of a client. For instance, you may be able to determine if a client has a cash flow problem, or it may prompt you to ask about production methodology or compare ratios to industry averages.
Australia has adopted International Financial Reporting Standards (IFRS) and a complete set of financial statements comprise the following:
- A statement of financial position as at the end of the period
- A statement of comprehensive income for the period
- A statement of changes in equity for the period
- A statement of cash flows for the period
- Notes, comprising a summary of significant accounting policies and other explanatory information; and
- A statement of financial position as at the beginning of the earliest comparative period when an entity applies an accounting policy retrospectively or make a retrospective restatement of items in its financial statements, or when it reclassifies items in its financial statements.
What do key financial statements mean to a business?
Cash flow is the heart of any business. It records money received (inflows) and disbursements made (outflows). The most important issue to consider is how long it takes clients to pay. Poor cash flow is the number one reason businesses fail. A successful organisation will usually have a well-managed credit policy.
Remember – Inflows should at least meet outflows
Profit & Loss
The Profit & Loss report outlines the current income and expenses of the business. Managers will be able to ascertain how well:
- Sales targets are being met;
- They control expenses; and
- The amount of profit or loss recorded for the business.
Growth can put a strain on cash flow therefore increases in sales does not necessarily mean the same increase in costs.
Remember – Making a profit doesn’t necessarily mean the business is coping
The balance sheet is prepared to show the financial situation of a business at a precise moment in time. It shows the reader what the financial condition is operating within an organisation. It is usually prepared on the last day of the financial period i.e. 30 June and is read as if the organisation was frozen in time. It does not record inflows and outflows of assets or liabilities; it only records the balance date at the reporting period.
Tests and Ratio’s
There are a number of useful accounting tests that can be utilised to determine the financial strength of an entity. As an example the following are basic tests and fit into two categories:
|Basic test of short-term solvency||The Acid Test Ratio||Debt to Equity Ratio|
|Total Current Assets / Total Current Liability||Cash + Account Receivables / Total Current Liabilities||Total Liabilities / Total Shareholder’s Equity|
Return of Investment Ratio’s
|Return on Equity||Return on Assets||Asset Turnover Ratio|
|Net Income / Total Shareholder’s Equity||Operating earnings before Interest and Income Tax / Total Assets||Sales Revenue / Total Assets|