State basic financial reporting elements and who is affected by finance,
The main purpose of studying finance is to gain an understanding of the financial performance of a company, corporation or industry. By looking at a company’s financial performance, decisions can be made about many things by many different players. Corporations are rated by different agencies that examine financial records and potential for growth. Fitch ratings are a good example of this. My employer has an A++ Fitch rating. This high rating allows a non-profit company to borrow money at lower interest rates. In a publicly held company, which is one that has shareholders, the main concern is to keep the shareholders happy. Shareholders infuse corporations they believe in (usually based on financial performance) with capital. When a company is considered a poor financial risk, the public will not be in a hurry to buy its stock.
So who is affected by finance? Shareholders, as mentioned previously, are the focus in publicly traded companies. They are not the only people who think about financials, however. The CEO, CFO and any other “C” position have accountability to report to the board about the financial performance of the company. Management is responsible for creating and maintaining both capital and operational budgets. Employees are required to maintain certain standards of productivity. Customers are affected by finances as well. Consider gas prices, and how increased costs in production are passed on to the consumer.
When looking at a company’s finances, there are essentially four items to consider: the income statement, the price earnings ratio, the balance sheet, and the statement of cash flows, (Block, 2005). The income statement is a tool used to measure profitability over a given period of time, i.e. quarterly, annual. The income statement evaluates the cost of producing goods or services and the money that was made as a result of selling those goods/services. Gross profit and net earnings are two key features to look at.
The price earnings ratio measures the relative valuation of earnings, (Block, 2005). This is a way of looking at how your company’s stock earnings compare to other companies both within and outside your industry. This ratio is affected by many variables like marketability, sales growth, and the debt-equity structure of a company.
The balance sheet shows what a company owns, and whether that capital is financed or owned, (Block, 2005). The balance sheet is like a snapshot of the company at one point in time. Company assets may include real estate, plant and equipment, inventory, and investments–like securities. One key element of the balance sheet is liquidity. This refers to the ability to convert assets into cash.
The statement of cash flows is used to emphasize the critical nature of cash flow with respect to a company’s operations, (Block, 2005). Like individuals, corporations have bills to pay. When an individual applies for a loan, the bank will look at a figure called the debt to income ratio. This ratio will tell the lender if the individual will be able to make their mortgage payments, car payments, utilities, etc. based on their current income. This is analogous to a company’s cash flow statement.
Using this basic information, financial analysts can perform more detailed research on the numbers. Ratio analysis, The Dupont Analysis and Trend Analysis are three examples of how financial analysts can use numbers to determine strength of performance and return on investment, (Block, 2005).
When corporations are required to report their financials, they report by the Statement of Financial Accounting Standards, (SFAS), (Block, 2005). This standard includes the income statement, the balance sheet and the statement of cash flows.
With an understanding of the basic financial reporting elements and who is affected by finance, it is time to consider how financial information can be used to make decisions. As mentioned above, more detailed financial analysis yields information on performance. Companies may choose to review their operations or supply chain management if they feel that improving them will reduce costs and increase profitability. Financial information may help steer a company to make decisions about what products or services they want to continue offering, or what services they may want to add.