Your Guide to Making Informed Financial Decisions – Knowyourfounder (2024)

Imagine a scenario where a small company is vying for success in a highly competitive market. Despite its innovative products and hardworking team, the company finds it challenging to secure funding from potential investors. The reason behind this is not the lack of potential in the business, but rather the absence of a well-prepared financial report.

The financial report is a powerful tool that can provide crucial insights into a company\’s financial health, performance, and potential, attracting investors or deterring them. In this blog, we will explore the importance of financial reporting, understand how it is prepared, and learn how to make informed financial decisions based on these reports.

Why Financial Reporting Matters

Financial reporting is the process of presenting a company\’s financial performance and position to different stakeholders, including investors, creditors, and management. It goes beyond accounting records and provides insights into a company\’s profitability, liquidity, solvency, and efficiency. Understanding financial reports helps businesses make strategic decisions, attract potential investors, and secure funding for growth and expansion.

The Different Types of Financial Statements

Alt Text: Types of financial statement

Source: MyPrivateTutor

Financial reporting relies on various financial statements that together paint a comprehensive picture of a company\’s financial situation. Let\’s take a look at some of the most commonly used financial statements:

1. Profit and Loss Statement (Income Statement)

The income statement shows a company\’s revenues, expenses, and profits for a specific period, typically one year. It provides crucial information about a company\’s ability to generate profits and its overall financial performance.

2. Balance Sheet

The balance sheet provides a snapshot of a company\’s financial position at a specific point in time. It shows the company\’s assets, liabilities, and shareholders\’ equity. This statement is useful for assessing a company\’s liquidity, solvency, and overall financial health.

3. Cash Flow Statement

The cash flow statement tracks the movement of cash in and out of a company over a specific period. It shows how a company generates and uses its cash, providing insights into its ability to meet its financial obligations and fund its operations.

4. Statement of Changes in Equity

This statement shows the changes in a company\’s equity over a specific period. It provides information about the shareholder\’s contributions, dividends, and retained earnings.

5. Notes to the Financial Statements

These are additional disclosures and explanations that accompany the financial statements. They provide further details about the company\’s accounting policies, significant transactions, and potential risks.

Preparation of Financial Statements

Alt text: Steps in financial statement preparation

Source: Finance Strategists

The process of preparing financial statements involves several steps:

1. Recording transactions

Financial transactions, such as sales, purchases, and expenses, are recorded accurately and timely using accounting software or manual bookkeeping methods.

2. Classifying transactions

Transactions are categorised and grouped into various accounts, such as revenue, expenses, assets, and liabilities.

3. Adjusting entries

At the end of an accounting period, adjusting entries are made to ensure that revenues and expenses are recognized in the correct period and that assets and liabilities are accurately reflected.

4. Closing entries

At the end of the accounting period, temporary accounts, such as revenues and expenses, are closed to the retained earnings account.

5. Preparation of financial statements

Finally, the prepared trial balance is used to create the financial statements, following a specific order – income statement, balance sheet, cash flow statement, and statement of changes in equity.

Analysing Financial Statements using Analytics

Alt text: Tools for financial statement analysis

Source: Tofler

By applying analytical tools and techniques to financial data, companies can gain valuable insights and make more informed decisions. Some key ways analytics is used in finance include:

1. Trend analysis

Analytics can help identify patterns and trends in financial data, allowing businesses to make predictions and forecast future performance.

2. Comparative analysis

By comparing financial data with industry benchmarks or competitors, companies can gain a better understanding of their performance relative to others in the market.

3. Financial ratio analysis

Analysing financial ratios, such as liquidity ratios, profitability ratios, and solvency ratios, provides insights into a company\’s financial health and performance.

4. Predictive modelling

Using historical financial data, predictive modelling techniques can help forecast future outcomes and identify potential risks and opportunities.

Example of a Projected Income Statement for 12 Months

Alt text: An example of income statement

Source: Course Hero

To illustrate how a projected income statement might look, let\’s demonstrate with a company. Here\’s an example for the next 12 months:

Revenue

• Sales: $500,000
• Other Revenue: $25,000

Expenses

• Cost of Goods Sold: $250,000
• Marketing and Advertising: $50,000
• Salaries and Wages: $125,000
• Rent and Utilities: $30,000
• Other Expenses: $20,000

Net Income: $50,000

Please note that this example is for demonstration purposes only, and actual figures may vary depending on the company and industry.

What Investors Look for in Financial Statements

Alt text: What to look for in a financial statement

Source: GETMONEYRICH

When evaluating financial statements, investors typically focus on key aspects that provide insights into a company\’s financial health and potential. Some crucial information they look for includes:

1. Revenue growth

Investors want to see consistent revenue growth over time, as it indicates a company\’s ability to generate income and attract customers.

2. Profitability

Investors examine a company\’s profitability ratios, such as gross profit margin, operating margin, and net profit margin, to assess its ability to generate profits.

3. Cash flow

Positive and healthy cash flows are essential for a company\’s sustainability, as it ensures that the business can meet its financial obligations and invest in growth opportunities.

4. Debt levels

Investors analyse a company\’s debt levels and debt-to-equity ratio to determine its financial solvency and stability.

5. Return on investment(ROI)

Investors will also consider a company\’s return on investment metrics, such as return on assets and return on equity, to gauge its efficiency and effectiveness in generating returns for shareholders.

What Information an Annual Financial Report Contains and How It Should Be Presented

Alt text: Contents of an annual report

Source: Venngage

An annual financial report typically consists of the following sections:

1. Management\’s Discussion and Analysis

This section provides an overview of the company\’s financial performance, including an analysis of the financial results, strategic initiatives, and any significant events or risks.

2. Financial Statements

The financial statements, including the income statement, balance sheet, cash flow statement, and statement of changes in equity, are presented in this section.

3. Notes to the Financial Statements

Detailed explanations and disclosures related to the financial statements are included in this section. It provides additional context and information about specific accounting policies, significant transactions, and potential risks.

4. Auditor\’s Report

The auditor\’s report, prepared by an independent auditor, provides an opinion on the fairness and reliability of the financial statements. This section is crucial for providing assurance to stakeholders.

5. Other Relevant Information

Additional information such as supplementary schedules, explanatory notes, and risk management disclosures may be included to provide a comprehensive understanding of the company\’s financial position and performance.

The Key Financial Statement Assertions

Alt text: Relevant financial statement assertions

Source: Woodlands Adventist

When preparing financial statements, it is important to ensure certain assertions are met to ensure accuracy and reliability. The five key financial statement assertions are:

1. Existence or occurrence

Assets and liabilities recorded in the financial statements exist and transactions have occurred.

2. Completeness

All transactions and information that should be included in the financial statements are included.

3. Valuation or allocation

Assets, liabilities, revenues, and expenses are recorded at appropriate values.

4. Rights and obligations

The company has legal rights to the assets included in the financial statements, and liabilities represent actual obligations.

5. Presentation and disclosure

Financial statements are presented in a clear and understandable manner, following applicable accounting standards and providing all necessary disclosures.

The Bottom Line

In conclusion, financial reporting is a powerful tool that helps businesses make informed financial decisions, attract investors, and assess their overall financial health and potential. By understanding the different types of financial statements and the steps involved in their preparation, businesses can gain valuable insights and use analytics to analyse their performance.

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