Question

Discuss the importance to a small business for maintaining complete and accurate financial statements and the role they play in identifying liquidity, activity, leverage, and profitability.

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Answer 1

Importance to small business for maintaining complete and accurate Financial Statements (FS)

1. Evaluation of tax liability

The complete and accurate FS assist in correct estimation of tax liability and hence results in avoiding interest and penalty.

2. Accurate financial position

The maintaining of the complete and accurate FS assist in arriving at accurate financial position which is a base for better decision making.

3. Assessing the financial needs

The accurate FS helps in correctly determine the future financial requirements and help to plan the same.

4. Performance assessment

Actual performance of the business can only be assessed if the financial statement are complete and accurate.

5. Better decision making and planning

The financial statements are analysed to make future forecast and plans. If the FS are accurate and complete the decision making and plans will be effective.

Role played by FS in identifying liquidity, activity, leverage, and profitability.

To identify liquidity, activity, leverage, and profitability of business various ratios are     calculated such as :-

liquidity	Current ratio, quick ratio etc
activity	Asset turnover ratio, Inventory turnover ,etc
leverage	Debt Equity ratio, Equity to total assets etc
profitability	Net profit ratio, Gross profit ratio, etc

All these above ratios require inputs from the items of FS, so only if the FS are complete and   accurate the ratio will show the true image of the business.