BUSINESS FINANCE

Balance Sheet/Statement of Financial Position - The balance sheet is considered as one of

the financial statements and is focused on financial accounting. The balance sheet shows the
company’s total assets, and how these assets are financed, through either debt or equity. It can
also sometimes be referred to as a statement of net worth, or a statement of financial position.
The balance sheet is based on the fundamental equation: Assets = Liabilities + Equity

a. ASSETS – Resources controlled by the entity as a result of past events and fro which
future economic benefits are expected to flow to the entity
b. LIABILITIES – Present obligations of the entity arising from past events, the
settlement of which is expected to result in an outflow from the entity of resources
embodying economic benefits
c. EQUITY - The residual interest in the assets of the entity after deducting all its
liabilities

Income Statement/Statement of Comprehensive Income - An income statement is a financial

statement that reports a company's performance over a specific period. Financial performance is
assessed by giving a summary of how the business earns its revenues and incurs its expenses
through both operating and non-operating activities. It also shows the net profit or loss incurred
over that accounting period.

a. Income – Increases in economic benefits during the accounting period in the form of
inflows or enhancements of assets or decreases in liabilities that result in increases in
equity, other than those relating to contributions from equity participants
b. Expenses- Decreases in economic benefits during the accounting period in the form
of outflows or depletions of assets, or incurrence of liabilities that result in decreases
in equity other than those relating to distributions to equity participants

Cash Flow Statement - In financial accounting, a cash flow statement, also known
as statement of cash flows, is a financial statement that shows how changes in balance sheet
accounts and income affect cash and cash equivalents, and breaks the analysis down to
operating, investing and financing activities.

Notes to Financial Statements - Text attached to a company's income statement, balance sheet,
or other financial document to explain unusual entries or items. These notes help company
decision makers and shareholders understand the accounting methods and practices employed by
the company, while preserving readability of the body of the document itself. Usually, this also
includes potential/contingent transactions that cannot valued as of given date but may affect the
decision of people concerned.

Annual Company Report –   This is a comprehensive report on a company's activities

throughout the preceding year. Annual reports are intended to give shareholders and other
interested people information about the company's activities and financial performance.
Normally, this contains the achievements, future projects and potential problems of the company

All these statements are related in such a way that it gives a clearer picture of the company. It is
important to stress that in evaluating the performance of a particular entity, the financial
statements should be taken as a whole in order to avoid a misinterpretation of the viability and
the profitability of a company.

In financial reporting, the following must be observed:

1. Use prescribed formats.

a. Establish a clear objective (What is the amount of CASH?)
b. Identify the first step in solving the problem (What documents will I look into)
c. Obtain the information required for that step (What are the totals in the documents?)
d. Repeat for each successive step until the objective is achieved (Proceed to next
account - ex. MARKETABLE SECURITIES)
2. Prepare the corresponding Notes to Financial Statements using an intelligible and precise
language.
 3. Adhere to a single currency, the acceptable currency of the state or country where the
entity is situated. If there is a need to restate certain accounts to another currency,
indicate these under the Notes to Financial Statement, not in the financial statements
4. In order to evaluate the results of financial audits, these must be compared to a given
standard, i.e. industry averages.

BASIC CLASSIFICATION OF FINANCIAL RATIOS

1. LIQUIDITY RATIOS – indicate a firm’s ability to meet short-term obligations

a. Current Ratio – measures the ability to satisfy short term claims from existing current
assets
b. Quick Ratio (Acid Test Ratio) – measures entity’s capacity to settle it’s short-term
obligations using cash and near cash assets

2. ASSET MANAGEMENT RATIOS – indicate how efficiently a firm is using its assets to
generate sales
a. Average Collection Period – measures the ability of the company to collect it’s net
credit sales
b. Inventory Turnover – measures the ability of the company to sell its products within a
given year or accounting period
c. Fixed Asset Turnover – measures the capacity of the company in using property plant
and equipment to generate sales
d. Total Asset Turnover – measures the capability of the company to generate sales
given all of its resources

3. FINANCIAL LEVERAGE MANAGEMENT RATIOS – indicate a firm’s capacity to

meet short- term and long-term obligations
a. Debt Ratio – measures the portion of assets financed by creditors
b. Debt-to-Equity Ratio – measures the amount of liability vis-a-vis the investment of
the owner
c. Times Interest Earned – states the firm’s capacity to pay current interest payments
using current earnings
d. Times Fixed Charges Earned –states the firm’s capacity to cover total fixed charges

4. PROFITABLITY RATIOS – measures how effectively a firm’s management generates

profits on sales, assets and stockholders’ investments
a. Gross Profit Ratio – measures if product or service is costly or not
b. Net Profit Ratio – measures the capacity of a firm to control operating expenses
c. Return on Investment – measures the viability of the investment of both creditors and
owners combined
d. Return on Stockholders’ Equity – measures the rate of return a stockholder gets on his
investment

5. MARKET-BASED RATIOS – measure the financial market’s evaluation of a company’s

performance
a. Price-to-Earnings Ratio – measures the risk associated with a company
b. Market-to-Book Ratio – measures the viability of a share of stock

6. DIVIDEND POLICY RATIOS – indicate the dividend practices of a firm

a. Payout Ratio – indicates the amount of earnings that are paid as dividends
b. Dividend Yield – indicates the attractiveness of the share of stock

Ratio should be considered in relation to other ratios and not taken into consideration
individually.
Remember the following:

1. Any discussion of financial ratios is likely to include only a representative sample of

possible ratios. It is possible that businesses in the same industry would have very
different ratios.
2. Financial ratios are only “flag” indicating potential areas of strengths and weaknesses. A
thorough analysis requires the analysis of other data, including qualitative data as well.
3. Frequently, a financial ratio must be dissected to discover its true meaning. It is very easy
to manipulate financial statements to paint a very different picture of an entity that you
are trying to evaluate.
4. A financial ratio would only be meaningful when it is compared with a given standard.
5. When financial ratios are used to compare one firm with another, it is important to
remember that differences may occur because of differences in accounting techniques

ANALYSIS OF PAST AND PRESENT PERFORMANCE

1. Vertical Analysis – comparison of amounts/entries within the financial statements. For

the balance sheet, this approach breaks down the percentage of individual asset accounts
in relation to the total assets of the company, the portion of liabilities and equity in
relation to the total assets of business. For income statements, revenue is presented at
100% and everything is broken down in terms of percentage. This presents a clearer
picture of the entity. For its balance sheet, one can determine whether there is a healthy
balance in the assets of the company. For the income statement one can easily see which
expense should be controlled/minimized in order to maximize profits.

2. Horizontal Analysis – This determines the progress/retrogress of an entity inasmuch as

the comparison will be for the same account from previous year. Using the previous
figures, one can determine what accounts went up and their relationship to one another.
As an example, there might be an increase in revenue but the corresponding increase in
expenses are much higher resulting in a much lower percentage increase in profits.

3. Trend Analysis – In relation to horizontal analysis, this is a variation of the said analysis
in that this covers more than two (2) accounting periods to establish the direction of the
entity and to evaluate the company more appropriately.

Know the formulas for the ratios