Financial Statement Analysis and Financial Forecasting

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Financial Statement Analysis and Financial Forecasting

4.1 Introduction. The lesson will consist of basic financial statements, its relevancy, reliability and quality as a basis for making decisions. Focus on the decision-making role of accounting system has to be elaborated. Also ratio analysis as decision tool with forecasting models is discussed. The basis concept of preparation of financial statement and its usefulness is included with ratio analysis. Cash flow analysis and financial planning with forecasted financial statement are covered.

4.2 Source of Financial Information. Accounting is the guide-post for management. A firm should know the financial implications of its operations. The financial score of the firm is kept by the accounting system. It points out the problems faced of likely to be faced by the firm. It indicates possible action, when needed. Accounting may be defined as “the process of identifying, measuring and communicating economic information to permit informed judgments and decisions by users of the information.”

4.3 Financial Statements. A firm communicates financial information to the users through financial statements and reports. Financial statements contain summarized information of the firm’s financial affaires, organized systematically. They are the means to present the firm’s financial situation to the users. Preparation of the financial statement is the responsibility of top management. As these statements are used by investors and financial analysts to examine the firm’s performance in order to make investment decisions, they should be prepared very carefully and contain as much information as possible. Two basic financial statements prepared for the purpose of external reporting to owners, investors and creditors are; 1. Balance sheet or statement of financial position and 2. Profit and lost account or income statement.

4.3.1 Objectives of Financial Statements. Financial statement prepared from the accounting records which are maintained by the firm. The generally accepted accounting principles and procedures are followed to prepare theses statements. The basic objective of financial statement is to assist in decision-making. The other objectives are; Resource and obligations; To provide reliable financial information about economic resources and obligations of a business enterprise. Changes in net resources; To provide reliable information about changes in net resources of an enterprise that results from the profit-directed and other activities.

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Earnings potential; To provide financial information that assist in estimating the earning potential of the enterprise. Full disclosure; To disclose, to the extent possible, other information related to the financial statement that is relevant to statement users.

4.3.2 Balance sheet. Balance sheet is the most significant financial statement. It indicates the financial conditions or the state of affairs of a business at a particular movement of time. More specifically, balance sheet contains information about resources and obligations of a business entity and about its owners’ interest in the business at a particular point of time. Thus the balance sheet of a firm is prepared on specific period of time, generally for a year. In the language of accounting, balance sheet communicates information about assets, liabilities and owners’ equity for a business firm as on a specific date. It provides snapshot of the financial position of the firm at the close of the firm’s accounting period. The following equation elaborates the relationship between assets and liabilities of the balance sheet. Total Assets (TA) = Total Liability (TL) + Owners’ Equity (OE)

4.3.3 Functions of the Balance Sheet. The three important functions served by the balance sheet are; It gives a concise summery of the firm’s resources and obligations. It is a measure of the firm’s liquidity. It is a measure of the firm’s solvency. We know the...
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