Accounting transactions are what come together in order to create financial statements. These transactions could either indicate money coming in and expenditure. Depending on the transaction, certain accounting principles are used in the treatment of the transactions. According to Franklin et.al (2019), generally accepted accounting standards are a set of rules, standards and concepts that assist in preparation of financial statements. These standards are valuable in the classification of accounting transactions. Most of these standards are used throughout the world and help to ensure that transactions are recorded in a uniform manner, can be compared with others and gives a certain reliability of the records. Certain streams of revenue require transactions to be recorded or recognized in accordance with these standards. If the transactions are not properly recognized, it may give the wrong picture of the financial statements. These statements give an indication of how a business is doing and can jeopardize possible investments and reduce the trust of shareholders. No matter how small a transaction may seem, every transaction plays a role in the creation of financial statements.
Financial statements are made up of four basic statements that include; the balance sheet, income statement, statement of shareholder’s equity and the cash flow statement. According to Edwards et.al (N.D), the balance sheet is what gives a picture of the value of assets at a given time and how the assets were financed. The recording of the assets is shown by virtue of which assets are easier to be liquated as the first, and subsequent ones being less easy to liquidate. The liabilities are shown by which obligations are due when, the short term liabilities are the first ones, followed by the long term liabilities. The income statement highlights costs and revenue that a business incurred over a period of time, this can be monthly, quarterly or yearly. The first part of the income statement represents sales or revenue that comes in in relation to any products sold or services rendered that are in line with the normal business focus. It contains more costs, some of which may be not cash related like amortization and depreciation. After all expenses or income is recorded it will show whether or not a business has made a profit or loss. This statement is linked to the balance sheet and shows the changes that occurred in relation to equity belonging to shareholders and stockholder value. This information is shown for a certain duration or accounting period. The statement of cash flows is what highlights how much actual cash was brought in through sales. A business needs to be aware of the actual money available to meet obligations, this statement helps show this. In order to ascertain the cash that came in and was spent a look at balance sheet changes in the period are used, additionally figures from the income statement are also used.
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Financial analysis is what digs further into financial statements to understand what the figures mean and represent. According to Edwards et.al (N.D), a critical look at these statements helps give a clearer picture of the position of a business; whether it is strong financially or struggling. Certain ratios can be calculated to help understand certain aspects of a business. For instance, grading the leverage and liquidity of a business can be done through analysis. These ratios will indicate whether or not a business has the capability to meet its obligations. Analysis will assist in ascertaining whether the revenue has been used effectively, what the cash was spent on and the value of a company’s assets. If a business hopes to get credit to assist in the purchase or expansion of operations, the credit institutions need to have a clear picture of whether the business is viable, this is done through a financial analysis.
References
Franklin, M. & Graybeal, P, & Cooper D. (2019). Principles of Accounting, Volume 1: Financial Accounting. OpenStax . https://openstax.org/books/principles-financial-accounting/pages/3-1-describe-principles-assumptions-and-concepts-of-accounting-and-their-relationship-to-financial-statements
Edwards, C., Hoang, V., Misik, B., Wine, K., & Zummo, J. (N.D). The Basics of Financial Statement Analysis: From a Credit Professional’s Perspective . https://nacm.org/nacm-blog/3112-starters-guide-to-financial-statement-analysis.html
