Different Components of a Financial Statement - Assignment Example

Executive Summary Financial statement forms an important aspect for every organization. The importance of it increases as business look to prepare different types of financial statements to ensure that the daily working of the business is recorded. Businesses lay more emphasis on the asset side and ensure that the assets are used in a way that it maximizes return for the future. The report looks into different financial statement prepared by businesses and sees the manner the different factors have contributed towards the growth and whether the increase in the value of assets is good or bad. The report looks into various assets like current, non-current and fixed. It then presents the manner it has contributed towards the growth and a recommendation for each individual asset is provided for. It also looks into the different aspect of cash flow and the importance of taxes that determine the performance of an organization. Table of Contents Introduction 3 Books maintained by business 3 Terminologies 3 Reason for maintaining financial statement 4 Different Components of a Financial Statement 5 Balance Sheet 5 Income Statement 11 Statement of Cash Flow 12 Statement of Stakeholder’s equity 13 Federal Tax System 13 Conclusion 14 References 15 Introduction Financial statement forms an important aspect for all organization and the importance multiplies for every organization as it helps to present the true value of the organization to the society. The report hereby presents the manner the different financial statements are prepared, the cash flow statement and the importance of taxes which businesses look to address through the financial statement. Books maintained by business It is imperative to keep the below mentioned report Simple cash book Cheque book Bank statement Debtors’ unpaid invoices. Creditors’ unpaid invoices. Balance sheet Income Statement Terminologies Profit is the difference between revenues and expenses. It is calculated as Revenues – Expenses. Assets: is defined as the items which are owned by the business and helps to generate future income. Example plant & machinery Liabilities: is defined as the sum of money which is owed by the business to outsiders Examples short term loan Balance Sheet: is financial statement which represents the value of assets and liabilities on a particular date. Profit & Loss Statement: is a statement which describes all business transaction incurred in a financial year and helps to calculate the profit or loss that the business incurred in that particular financial year. Source document are first record transaction. It is used to keep the record in a systematic way. It provides us information which is useful in the business. It includes cash book and journal Bank reconciliation statement is a statement which is prepared to remove the discrepancies which occur between the bank statement and bank book prepared by the business. It helps to identify those errors and remove Reasons for maintaining financial statements The reasons for keeping records are as follows- To ascertain profit or loss in the business To ensure changes in the planning process To control the costs of goods and services To identify the amount due from debtors To see which accounts is necessary to be paid To ensure business success To make insurance claim To decide future strategy for business To meet tax requirements Identifying the equipments to be purchased Different Components of a Financial Statement Financial statement comprises of different statement which businesses look to prepare to ensure that all information is disclosed to the public the different statements prepared are as follows Balance Sheet Balance Sheet: is financial statement which represents the value of assets and liabilities on a particular date. The balance sheet is divided into assets and liabilities. The following components forms the assets side Current Assets Currents assets are those “assets which can be converted into liquid cash within an operational cycle”. (Hafez, 2010) Operating cycle differs on the nature of business as some business has it less than a year and some more than a year. Normally assets which are converted into cash in a year is considered as current assets. This is an important aspect for every business because it determines the manner a business has liquidity. Current assets thus are in the following forms Cash form Will be realized as cash in short term like debtors Stocks or other units which will be converted into cash within an operating cycle or one year Every organization has to maintain current assets irrespective of its size. This is true for the banking sector as they provide liquidity by providing money to the borrowers. It is important to maintain liquidity and assets which will be shortly converted to cash. The current assets held by banks are as follows Cash & Bank Balances: This is the amount which banks have parked with the central bank. Every bank is required to deposit a certain percentage of cash with the central bank as the reserve requirements. Every country has prescribed a certain percentage of money which has to be kept with the central bank to ensure liquidity. This helps the economy as it ensures that banks don’t fail. (Heller & Lengwiler, 2003) Deposit and balances due from bank: These are the funds a bank has to pay another funds on a short term basis. These arise due to interbank transfers and are normally settled on a fortnight basis. (Hafez, 2010) This is a mechanism where different banks deal with each other. The transfer of funds happen due to settlement of securities transactions, cheques drawn on other banks, transfer of participating loans funds, and sale or purchase of Federal funds. (Hafez, 2010) Trading Securities: Trading securities are “securities which are held for a short time period with the intention to earn profits after selling the securities”. (Miranda, 2010) These securities can be held in the form of equity or debt. Generally trading securities are held as the risk is less and the returns are more. Despite brokerage firms recommending securities for long term trading securities are held for a short tenure. It is purchased when the prices are low and sold when it is high to earn profits. (Miranda, 2010) Other assets Other assets are those assets which cannot be classified as current, fixed or non-current assets. Other assets consist of advances made to officers, cash surrender value of insurance, cost of building in the process of construction and funds for held for special purposes. (Hafez, 2010) This constitutes an important part of the balance sheet and helps to ensure that these assets are converted into cash easily. Non-Current Assets Non Current assets are those assets which are neither current nor fixed. These are assets which are in between fixed and current and require a relative large period of time to be converted into cash. Banks and other institutions are seen to have an increase in the non-current assets as they are held midway and helps business units to ensure that some sort of liquidity can be maintained by disposing of these assets. Loans and Advances: Loans and advances forms the most important part for banks as these is the “money that has been lent to private institutions, people, business houses and government bodies”. (Smith, 2010) This is a major function of banks and banks lay special attention towards it to ensure that it grows. Banks provide loans and advances though overdraft facility, borrowing, loan, and credit financing and other mechanism. This is the most important constituent for a banking sector and special attention needs to be paid to ensure that it grows. Investment Securities: Investment securities are those “which are not meant to be sold in a short term but rather held for an investment purpose”. (Investment Securities, 2010) This are securities which are in the form of bonds, certificate of deposits, treasury bills, zero coupon bonds, and similar other investment securities. Banks are seen to invest in it as the risk involved is less due to bonds and securities which are backed by government so chances of failure are less. Investment in Associates: Investment in Associates is defined as “the investment in an enterprise where the investor has influence but is not a joint venture”. (Investment in Associates, 2010) Here the investment is made in a company where the investor has some control. This helps business to ensure that they control a subsidiary and can help them in the long run. Fixed Assets Fixed assets are those assets which have been acquired for long term functioning and are not meant for sale. (Hafez, 2010) These are assets like land and building, the bank premise, computers, and other equipments like furniture. These are assets which are acquired to ensure long term earning for the business units. Derivative Financial Instrument: Derivative Financial Instrument is “those instruments which are held for a long purpose and the value of the instrument is derived from the value of the underlying assets”. (Porterfield, 1994) These are instruments like puts, calls, swaps and, options. Financial institutions invest in it due to the probability of fetching a higher return in the long term. Investment Properties: Investment Properties are “properties which are purchased with the intention of earning profits while selling off the asset”. (Investment Properties, 2010) This can take various forms like purchase of flat, building, land, and other properties. The profit by investment in these properties can be through rent received on them, capital income when they are sold, and both. Property and equipment: Property and equipment are “assets which are long of long term and are acquired to ensure income through the usage of it”. (Kennon, 2010) These are pure long term assets and are acquired to help business units earn revenue in the future. Some of the types of assets are furniture, fittings, premises, land and building, and other office equipments. Normally a certain percentage of assets have to be acquired to ensure daily work. Liabilities side of the balance sheet comprises of the following elements Shareholders equity It shows the amount of money contributed by the owners. In case of a proprietorship it is the capital of the proprietor himself and in case of public companies the money is raised by issuing shares to the public (Equity, 2011). Current Liabilities These are the external obligations of the organization which are met in a period of one year. They are short term in nature and are met through the current assets (Kennon, 2011). Some of the current liabilities are as follows Accounts Payable: This is the amount that the businesses need to pay to its creditors which includes the suppliers of materials. They are of short term and businesses look towards paying those to improve the goodwill of the business (Kennon, 2011) Short term debt: is the amount of funds that has been borrowed and will be paid in within a period of one year (Kennon, 2011). Accrued Benefit: is a current liability for a business as the benefit from the same has been consumed but has not been compensated accordingly. For example outstanding insurance premium amount (Kennon, 2011). Long Term Debt Businesses for their daily functioning borrow funds which are held for more than an accounting year and are of long term nature. This are held to ensure that the operations of the business is carried out effectively and businesses are able to maximize their benefit from it. (Kennon, 2011) Income Statement Income Statement: is a statement which describes all business transaction incurred in a financial year and helps to calculate the profit or loss that the business incurred in that particular financial year. It comprises of the following Net Sales: It is the amount of revenue that the business has generated in an accounting cycle and results from the normal operations of the business (Loth, 2010) Cost of Sales: It is the amount that is spend to covert the materials into saleable products which a business incur so that the market requirements can be met (Loth, 2010) Gross Profit: is the difference between revenue and cost of sales and is calculated after all the direct expenses have been adjusted for (Loth, 2010) Selling & distribution expense: is the amount of indirect expense incurred by a business to ensure that the goods are delivered to the customers (Loth, 2010) Operating income: is the income which is calculated after all the indirect expenses have been charged for (Loth, 2010) Interest: is the amount of money that the business pays on borrowed funds and have to be charged (Loth, 2010) Pretax income: Charging the interest expense helps to arrive at pre-tax income (Loth, 2010) Income tax: Businesses on their income have to pay taxes to the government as determined by the law (Loth, 2010) Net Income: Reducing the income tax helps to arrive at the income that is attributed to the owners of the business (Loth, 2010) Cash Flow Statement Cash flow statement helps to ascertain the cash inflows, outflows and the timings of the inflows and outflows. This helps the business to ascertain that they don’t face a liquidity crunch (Cash Flow Statement, 2011). It comprises of the following Operating Activities: It provides details regarding the inflows and outflows accounting due to the daily operations of the business thereby helping to find the management of cash in the business (Averkamp, 2011) Investing Activities: It provides details regarding the inflows and outflows accounting due to the investing activities of the business like purchase of plant & machinery (Averkamp, 2011) Financing Activities: It provides details regarding the inflows and outflows accounting due to the financing activities of the business like purchase of bonds (Averkamp, 2011) Statement of Stakeholders equity Statement of stakeholder’s equity helps to find out the changes in the value of the equity due to the operations of the business. It shows the growth in the amount of capital due to various factors and the manner in which businesses was able to gain from it. (Stockholders Equity, 2011) It comprises of the following Stock or equity: It is the amount of share capital that that has been raised by the public or inserted by the proprietor in the business itself (Stockholders Equity, 2011) Retained earnings: is the amount of earnings that has been retained and is accrued to the stakeholders. (Stockholders Equity, 2011) Federal Tax System Federal Tax system determines the tax rate that has been imposed on different individuals and organizations. Businesses need to ensure that they ay their taxes on time so that they avoid government problems. The tax structure has been designed in a manner where higher income means higher taxes thereby making the businesses follows a progressive tax structure. The tax rate for different income is different. For example corporation taxes vary from 10% to 35% thereby making higher income company pay higher taxes. It is seen that a corporation with an income of 10 million pays a tax rate of 10%. In addition to the mentioned taxes businesses also have to pay the state levied taxes and other taxes that accrue to their business thereby increasing the pressure on the business. Conclusion Businesses thus look towards preparing financial statement and also look towards adhering to the government regulations so that they are able to gain maximum leverage from it. Businesses look to ensure that their financial statement is complete in all respect so that maximum information can be provided to the user. Along with it businesses look towards providing transparency and reliable information. All the different components of the financial statement and ways it is managed helps to ensure whether the business will be successful in the long run. References Averkamp, H. (2011). Cash Flow Statement. Retrieved on April 25, 2011 from http://www.accountingcoach.com/online-accounting-course/06Xpg01.html Cash Flow Statement. (2011). Cash Flow Statement. Retrieved on April 25, 2011 from http://india.smetoolkit.org/india/en/content/en/828/Cash-Flow-Statement Equity. (2011). Reading the Balance Sheet. Retrieved on April 25, 2011 from http://www.investopedia.com/articles/04/031004.asp Hafez, Z. (2010). Analysis of financial statement – liquidity of short term assets. The New York Times Company Heller, D. & Lengwiler, Y. (2003). Payment obligations, reserve requirements, and the demand for central bank balances. Journal of Monetary Economies, 50 (2), 419-432 Investment Securities. (2010). Investment Securities. Economy, Investment & Finance Reports, Economy Watch Investment in Associates, (2010). Accounting of Investment in Associates. IAS 28, Deloitte Investment Properties. (2010). Investment Properties. Economy, Investment & Finance Reports, Economy Watch Jennon, J. (2011). Current Liabilities. Retrieved on April 25, 2011 from http://beginnersinvest.about.com/od/analyzingabalancesheet/a/current-liabilities.htm Kennon, J. (2010). Property, plant & equipment. analyzing a balance sheet, about.com Loth, R. (2010). Understanding the income statement. Retrieved on April 25, 2011 from http://www.investopedia.com/articles/04/022504.asp Miranda, K. (2010). What is trading securities Personal Finance, ehow.com Porterfield, L. (1994). Derivative financial instrument: time for better disclosure. The CPA Journal Stockholders Equity. (2011). Statement of Stockholders Equity. Retrieved on April 25, 2011 from http://finance.mapsofworld.com/financial-report/basic/statement-of-stock-holders.html Smith, G. (2010). Loans & advances. Ideal cash advances, 2010. Retrieved on April 25, 2011 from www.idealcashadvancs.com Read More