Economics Homework Help

Many people regard financial statements as just accounting and a bunch of numbers. However, after reading Chapter 3 & 4, we know this is not an accurate assessment and the financial statements provide very valuable information. 

Using the information and knowledge gained, explain why the financial statements are much more than simply accounting and numbers. Your assessment should include a discussion of each of the financial statements, what each statement represents, and its importance. In addition, you will discuss the different financial ratio categories, what they tell us, along with why the statements and ratios are important to managers, creditors, and investors.

Reply:

When those around you are not a business major, they will probably not see a sheet with a bunch of numbers and calculations regarding the finances of a company. Those that are business majors will but may not utilize their knowledge and some may think it is all the same stuff. But when you are a business finance major, you get to see the true differneces between business majors, and specificsally, you get to differentiate accounting and finance. Financial statements convey a lot of useful information that helps corporate managers assess the company’s strengths and weaknesses and gauge the expected impact of various proposals. Outsiders also rely heavily on financial statements when deciding whether they want to buy the company’s stock, lend money to the company, or enter into a long-term business relationship with the company. Financial statements are stressful and overwhelming, but if you know what you are specifically looking for, it will be easier not only for the company, but also for you. There are four financial statements and each one is more than just accounting and numbers, the list below will includ all four, including the financial ratios and explain the importance of each one.

The Balance Sheet: shows what assets the company owns and who has claims on those assets as of a given date. The balance sheet is a ‘snapshot” of a firms position at a specific point in time. The left side of the statement shows the assets that the comapany owns, while the right side shows the liabilities and stockholders’s equity. In the balance sheet, there are seven important points that should be noted, and explain more on why financial statements are more that just accounting and numbers. !. Cash Versus other assets: only the cash and equivalents account represent actual spendable money. 2. Working Capital: current assets are called working capital because these assets “turn over” meaning that they are used and than replaced throughout the year. 3. Total Debt versus total liabilities: a company’s total debt includes both its short term and long term interest bearing liabilities. 4.Other sources of funds: most companies finance their assets with a combination of short term debt, long term debt and common equity. 5. Depreciation: Companies prepare two sets of financial statements. 6. Market values versus book values: Companies use GAAP to determine values reported on their balance sheet. 7. Time Demension: the balance sheet is a snapshot, for example: December 31, 2020. With all of this, there is an order in which everything listed on the balance sheet is placed and made up of.

The Income Statement: which shows the firm’s sales and costs (and thus profits) during some past period. Net sales are shown at the top of the statement; then operating costs, interest, and taxes are subtracted to obtain the net income available to common shareholders. We also show earnings and dividends per share, in addition to some other data. Earnings per share (EPS) is often called “the bottom line,” denoting that of all items on the income statement, EPS is the one that is most important to stockholders. The income statement reports on operations over a period of time. The income statement and balance sheet are connected through the retained earnings section on the balanace sheet.

The Statement of Cash Flows: shows how much cash the firm began the year with, how much cash it ended up with, and what it did to increase or decrease its cash. In finance, cash is king. This report shows how much cash a firm is generating. This statement is divided into four sections. Operating: This section deals with items that occur as part of normal ongoing operations. Investing: All activities involving long-term assets are covered in this section. It also includes the purchase and sale of short-term investments, other than trading securities, and lending and collecting on notes receivables. Financing: Deals with how company’s raise and pay back capital. which shows the net flows of cash that are used to fund the company. Financing activities include transactions involving debt, equity, and dividends. Summary: This section summarizes the change in cash and cash equivalents over the year. Managers strive to maximize the cash flows available to investors,

The Statement of Stockholder’s Equity: shows the amount of equity the stockholders had at the start of the year, the items that increased or decreased equity, and the equity at the end of the year. Changes in stockholders’ equity during the accounting period are reported in this statement. Stockholders allow management to retain earnings and reinvest them in the business, use retained earnings for additions to plant and equipment, add to inventories, and the like.

With this information you can answer these questions: How large is the company? Is it growing? Is it making or losing money? Is it generating cash through its operations, or are operations actually losing cash? At the same time, investors need to be cautious when they review financial statements. Although companies are required to follow GAAP, managers still have a lot of discretion in deciding how and when to report certain transactions.All of this information contained in the annual report can be used to help forecast future earnings and dividends, and that is the reason why investors, creditors and managers hold this report, or moreso hold these financial statements because they can make or bresk their company.

The other reason why financial statements are more than jut accounting and numbers is because of the different categories of financial ratios, they are listed below.

Liquidity ratios: which give an idea of the firm’s ability to pay off debts that are maturing within a year. The liquidity ratios help answer this question: Will the firm be able to pay off its debts as they come due and thus remain a viable organization? If the answer is no, liquidity must be addressed. The two important liquidity ratios are the current ratio and the quick or Acid Test ratio.

Asset management ratios: which give an idea of how efficiently the firm is using its assets.They measure how effectively the firm is managing its assets. These ratios answer this question: Does the amount of each type of asset seem reasonable, too high, or too low in view of current and projected sales? The ratios included are: The turnover inventory ration, the days sales outstanding ratio, fixed assets turnover ratio, total assets turnover ratio.

Debt management ratios: which give an idea of how the firm has financed its assets as well as the firm’s ability to repay its long-term debt. The use of debt will increase, or “leverage up,” a firm’s ROE if the firm earns more on its assets than the interest rate it pays on debt. However, debt exposes the firm to more risk than if it financed only with equity. The following ratios are: total debt to total capital, times interest earnigs ratio.

Profitability ratios: which give an idea of how profitably the firm is operating and utilizing its assets. Reflects the net result of all of the firm’s financing policies and operating decisions.These ratios can potentially predict what may happen in the future. Operating Margin, Profit Margin, Return on total Assests, Return on Common Equity, Return in Invested Capital, Basic Earning Power.

Market value ratios: which give an idea of what investors think about the firm and its future prospects. ROE reflects the effects of all of the other ratios, and it is the single best accounting measure of performance. Investors like a high ROE, and high ROEs are correlated with high stock prices. Which relate the stock price to earnings and book value price. The Market Value Ratios are used in three ways. 1. By investors when they are deciding to buy or sell a stock. 2. by investment bankers when they are setting the share price for a new stock issue (an IPO). 3. by firms when they are deciding how much to offer for another firm in a potential merger. The following ratios are included: Price Earnings Ratio, Market Book Ratio, Enterprise Value/ EBITDA Ratio.

With all of these rations, we like to combine them and hence use the DuPont Formula. All of the ratios are important, but different ones are more important for some companies than for others. Satisfactory liquidity ratios are necessary if the firm is to continue operating. Good asset management ratios are necessary for the firm to keep its costs low and thus its net income high. Debt management ratios indicate how risky the firm is and how much of its operating income must be paid to bondholders rather than stockholders. Profitability ratios combine the asset and debt management categories and show their effects on ROE. Finally, market value ratios tell us what investors think about the company and its prospects.

Reply

Financial Statements are a crucial part of how a company reads and keeps track of finances and data coming in. Even though these statements look like a whole bunch of random numbers and statements they actually provide essential data in a specific way. Let us start out with the four main financial statements, Balance Sheets, Income statements, Cash Flow Statements, and Statements of Shareholders equity. First, a balance sheet shows the financial balances of a companys records. Income Statements show the revenue vs expense trend. They explain where money is coming in and where it is going out. Next, Cash flow statements show how changes in the balance sheet affect cash and things equal to cash. Finally, Statements of Shareholders equity show the relationship of revenue and how it applies to shareholders and their relative partners.

The financial ratios are as follows; price to earnings ratio, PEG ratio, Price to Sales ratio, Debt to Equity Ratio, and price to book ratio.

These two categories of data and data collection methods play a vital role in establishing a healthy company. They give managers a generalization on what needs to be changed to improve the company. This also gives investors and idea on what companies to invest in, as well as if they want to continue investing in a company. If the company is not looking healthy finacially would you want to continue to invest?