Question

Describe and summarize the key financial statements used in a business organization. Explain three to five key financial ratios used to analyze a company.

Answer 1

There are usually 4 financial statements that are used for the financial analysis of any company,

1. Income Statement:

This is also known as the profit/loss statement as it depicts the company's financial performance. For a specified period of time it tells about the loss/profit of the company. It consists of mainly 2 elements:

a. Income: All the income a company (revenue, sales, dividend etc.)

b. Expenses: All the cash expenses (salaries, depreciation etc.)

2. Cash Flow Statement:

It describes all the cash movements in and out of the company. It describes how the cash balances has moved from one account to other. It consists of

a. Investing activities: Cash flows from investment activities of the assets

b. Operating activities: Cash flows from primary activities of the business

c. Financing activities: Cash flows from fund raising or loan repayment

3. Statement of Owner's Equity:

It is also known as Statement of Retained Earnings which tells about the changes in equity and the corresponding details of movement over a particular time period. It is derived from:

- Net profit/loss

- Dividends

- Share capital repaid or issued

- Changes in accounting policy

4. Balance Sheet:

This gives information at a specific point of time for the company. It contains 3 elements:

- Assets

- Liabilities

- Equity

Asset = Liabilities + Shareholder's equity

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Financial Ratios:

1. Current Ratio:

It is one of the liquidity ratio which tells about the ability of the company to pay its short-term obligations. Higher value is a good sign.

Current Ratio = Current Assets / Current Liabilities

2. Quick Ratio:

It is famously known as "acid-test ratio" which tells about company's ability to repay short term obligations with its most liquid assets.

Higher value is a good sign.

Quick Ratio = ( Current Assets - Inventories) / Current Liabilities

3. Debt-Equity Ratio

It tells about the firm's financial leverage. It tells us how the company is managing its finance from equity and debt.

Debt-Equity Ratio = Total Liabilities / Shareholder's Equity

4. Return on Equity (ROE):

It shows that how company is using money and what return are generated from their investment.

ROE = Net Income / Shareholder's Equity