Application of Financial Statement - Assignment Example

Select either the balance sheet or income ment and explain how the use of it may be applied to your everyday life. The financial ment selected for the purpose of this part of this report is the Income Statement. The income statement shows the profit or loss incurred by a business entity over a period of one financial year (Wild, 2006). It shows the Net Sales less expenses which is the Income before Taxes. After deducting taxes from this income, we arrive at the Net Income or Income after Interest and Taxes. Whereas the Balance Sheet is less common in everyday life, the concept of income statement is very simple. It shows how much of the income has been taken away by expenses. Thus, in everyday life, the Income statement can be quickly and easily drawn up to show whether a person is generating positive income or a loss. If the person is incurring a loss, the income statement shows why this is so by providing a breakup of the expenses incurred. The individual can then know which expense is larger than the others and which expense can be easily controlled (Fridson & Álvarez, 2002). For instance, certain expenses such as house rent, fuel, heating and lighting of the house maybe unavoidable, but certain expenses such as food items maybe controllable. The purpose of this statement in everyday life is to ensure better control over expenses and how to economize on these expenses in order to generate sufficient income. The concept of “sufficient” income again varies from individual to individual so there is no such concept of a perfect income or desirable income. However, the idea is to prevent individuals from going into a loss by allowing them better control over their expenses and inducing them to save rather than spend. Using the same concept selected above, discuss how a business manager may benefit from an understanding of this statement. In a business setting, the income statement simply draws a comparison between revenues and expenses, showing which is higher. The usefulness of an income statement for business managers is not limited to the numbers per se. Ratios calculated by using these numbers provide more useful information for decision making. The income statement, to this end, provides a quick assessment of the firm’s overall risk from operations, profitability and flexibility of its operations. For instance, the Return on Investment is calculated partially by using the income statement and partially by the balance sheet. The Gross and Net Income figure provided by Income Statement is used in a lot of other ratios, such as Gross Profit Margin, Net Profit Margin, Return on Assets, and Return on Equity etc. The Gross Profit Margin is simply found by dividing gross profit by sales, which indicates how much profit is earned per dollar of sales, taking cost of goods sold into account (Wild, 2006). The Net Profit Margin, however, goes a step further in explaining the profitability and depicts the income earned per dollar of sales, net of expenses (Wild, 2006). Similarly, the income statement provides a rough measurement of the firm’s risks which are related to the firm’s future operations (Wild, 2006). The degree of operating leverage is also calculated using income statement which reflects the need to maintain a specific level of operations (Wild, 2006). The income figure reflects all those items that contribute towards the profit or loss during the particular accounting year, except for items that are adjusted to retained earnings figure in the Balance Sheet (Wild, 2006). Discuss how your understanding of the balance sheet and income statement may be applied to your current or future position. The Income Statement provides a true and fair view of the profit and loss realized by the company at the end of its financial year (Peterson & Fabozzi, 1999). It shows expenses that need to be controlled, which expenses are large enough and which are small so as to be ignored. Income Statements are prepared according to International Financial Reporting Standards in most countries and are a reflection of certain accounting principles such as the matching principle, revenue recognition principle and accruals principal. Income earned in a particular accounting period is matched to expenses incurred during that period. I view myself as a manager of a large MNC in future, and have an aptitude towards finance. Hence, knowledge of income statement and balance sheet is fundamental to my position in a finance department because these are the basis on which the pillars of finance are laid. In an MNC, there are strict rules and regulations of corporate governance to adhere to, and companies cannot be lax as far as preparation of these financial statements is concerned due to heavy fines and legal procedures that result. Furthermore, the existence of the company is linked to the preparation of these statements; hence, it is important to have knowledge about them. As a manger I may be required to check and proofread the statements prepared by the accounting clerk before the statements go for auditing. If I err and the auditor detects any flaw, the company can suffer from heavy penalty and be forced to appear before the court as well which can bring ill name to the company. The Balance Sheet also shows a true and fair view of the financial position of a company at the end of the accounting year (Peterson & Fabozzi, 1999). This statement shall be extremely useful; because, as a finance manager I shall be asked to analyze ratios prepared using information in the Balance Sheet such as Debt to Equity Ratio, Current Ratio etc. which are critical to the continued existence of a company. All leverage policies of the company surround around its capital structure; the Weighted Average Cost of Capital (WACC) is also calculated using information from the Balance Sheet, which is essential for financial risk-return comparisons in a company (Peterson & Fabozzi, 1999). Furthermore, the assets of an MNC are often large, requiring some sort of professional management from outside experts known as Asset Management Companies. A thorough analysis of these statements shall be made by outside investment companies before deciding to invest in the MNC. Also, banks often ask for financial statements before making any loan; the 5Cs of credit also emerge out of the Balance Sheet (Peterson & Fabozzi, 1999). Thus, as a finance manager my knowledge of these statements is quintessential. References: Fridson, M. S., & Álvarez, F. (2002). Financial statement analysis: a practitioners guide . New Jersey: John Wiley & Sons. Peterson, P. P., & Fabozzi, F. J. (1999). Analysis of financial statements. Pennsylvania: FJF. Wild. (2006). Financial Statement Analysis. New Delhi: Tata Mc Graw-Hill. Read More