Explain the impact of accounting transactions in financial statements
An accounting transaction is an event occurring and which affect the financial statements of a business. The events are recorded in the financial records of a business and tracking the sum of the transactions allows an accountant to analyze and predict the financial health of operations. Some of the accounting transactions include sales, purchase, and borrowings (Rice, 2015; Subramanyam, 2014).
All accounting operations in a business are part of the accounting equation, i.e., assets = liabilities + owner's equity. Any transaction that takes place must lead to a balanced equation. Some operations affect the assets of an enterprise by increasing or reducing their values. Similarly, they do affect the liabilities or the owner's capital depending on their nature. Any transaction that alters the above equation affects the financial statements of an enterprise. Cash borrowing, for instance, increases cash in the current assets of the balance sheet while at the same time raising the value of accounts payable by a similar amount. When the owner of an entity invests additional funds in the business, the investments go up as the value of owners equity increase by an equal amount (Rice, 2015; Subramanyam, 2014).
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Any transaction that alters the assets, liabilities or owner’s equity affects the balance sheet of an entity. Such operations can either increase the value of the asset while raising the liabilities or capital or can reduce all depending on the nature of such transactions. Any transaction affecting the sales, revenues, and expenses of an enterprise will affect the income statement by determining the net income of business over a stated period. Any transaction that affects cash in business either increases or decrease in operating, investing and financing activities will affect the cash flow statement (Rice, 2015; Subramanyam, 2014).
Describe the elements and purpose of each financial statement.
According to SFAC 6, there are ten elements of financial statements; assets, liabilities, equity, investments, distributions, revenues, expenses, gains, losses and comprehensive income. The elements are used to describe the financial position of an entity and its periodic performance. Assets are a company's probable future economic benefits. Anything that cannot be controlled by the business for instance employees is not an asset. Liabilities are future sacrifices for obligations arising in the present. Liabilities call for cash payment, transfer of other assets or provision of a service at an agreed future date. Equity is the residual value of the assets after the settlement of liabilities. I.e., it is the value of enterprise net assets. Equity can be from two sources; shareholders or retained profits. The three elements discussed above deals with the financial position of a company. They are recorded on the balance sheet which is a statement of the three at a given period and which details the balance of revenues and expenditures in the preceding period (Rice, 2015; Subramanyam, 2014).
Investments are increases in owner's equity as a result of cash transfer in exchange for ownership. Distributions are reductions of the equity as a result of assignment to the proprietor, for example, a cash dividend. The two are recorded in a statement of changes in equity which shows the movement of owner's equity in a company (Rice, 2015; Subramanyam, 2014).
Revenues, gains, expenses, losses are elements that are recorded in an income statement. They show the inflows or settlement of liabilities, proceeds from rendering a service or any other operating activities. Where inflows are not from central operations, the proceeds are gains. Any outflow from the business from its operations constitutes an expense. Losses arise from a decrease in the equity resulting from the transactions or incidentals (Rice, 2015; Subramanyam, 2014).
Discuss the components and use of financial analysis
Financial analysis has five major components which are used to analyze the financial health of any business. It consists of five unique areas of their data point and ratios. Revenues are the primary sources of cash for an enterprise. The success of a business is determined by the quantity, quality and timing of its revenues. Companies need to determine revenue growth, concentration and share per employee to understand how the three relate. Another area of concern is profits because businesses that are unable to produce it consistently are likely to face difficulties in their operations. Companies need to have a healthy gross, operating and net profit margin (Rice, 2015; Subramanyam, 2014).
The third component is operational efficiency which is determined by accounts receivables and inventory turnover. Companies need to analyze the capital effectiveness and solvency particularly important to the lenders and investors. Two ratios need to be computed, i.e., return on equity and debt to equity. The last component is liquidity which is the ability to generate adequate cash to cover expenses. Companies need to compute current ratio and interest coverage to understand their liquidity (Rice, 2015; Subramanyam, 2014).
References
Rice, A. (2015). Accounts demystified: the astonishingly simple guide to accounting . Harlow, England: Pearson Education.
Subramanyam, K. R. (2014). Financial statement analysis . California: University of Southern.
