The financial statements are prepared at the end of the year in an organization to present the actual financial position of a business.
A financial statement is compilation of data, which is systematically and logically organized according to the accounting principles. The financial information about the entity is necessary for a number of stakeholders like stockholders, creditors, and the general public.
The management committee of an organization requires financial data to make analysis and interpret the data for further decision-making. To cite an example, Rainbow-chem industries present their balance sheet in a vertical format, which comprises of two categories i.e. sources of funds and application of funds. Sources of funds include the funds raised from various sources like share capital, total reserves, secured and unsecured loans and total debts. Application of funds means the capital expenditure incurred by the firm to purchase long-term assets, accounts receivables and investments. The Profit and Loss Account reveals the routine income and expenses incurred by the firm at the year ending financial year.
The two main tools of financial analysis are the ratio analysis and funds flow analysis. To determine the liquidity position of the firm the relationship between the current assets and current liabilities are studied. Liquidity implies the firm’s ability to pay off the debts in the short run. If the firm has sufficient net working capital (excess of current assets over current liabilities) then it is assumed to have enough liquidity. The liquidity ratio is determined by dividing the current assets/ current liabilities. Current assets include cash, marketable securities, debtors, inventories, advances and prepaid expenses. Whereas, current liabilities include loans and advances borrowed, trade creditors, accrued expenses and provisions.
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