What types of questions can be answered by analyzing financial statements?
The analysis of financial statements involves the process of analyzing and reviewing the financial statements of an organization. In that regard, therefore, it helps to answer questions such as on whether to keep on with the holdings of the share of the company or have them sold out. Therefore, the analysis of financial statements offers essential information to the shareholders on executing such decisions. It is also effective in answering the question of decisions and plans and the investment decision. Through financial analysis, the organization is capable of formulating ideas, decisions, and policies for future investment (Penman, 2013).
- What is the difference between an annual report and 10-K report?
Whenever an organization sells its shares to the stock exchange market, the SEC usually takes the extra interest in their finances. It is out of such actions organizations are expected to file a report yearly as they update their performance. Therefore, this report is what is referred to as the 10-K. On the other hand, in an annual report, there is much flexibility in case the business is small. The annual report is a document prepared by an organization every year to detail their performance (Penman, 2013). It is through the annual report; the shareholders can easily track the performance of the business.
- What organization has the legal authority to set accounting policies in the United States? Does this organization write most of the accounting rules in the United States? Explain.
The organizations in the United States authorized in setting the accounting policies include the SEC. This organization has a congressional authority in setting up the accounting policies. Additionally, they have also been provided with the ruling to facilitate the setup, such as the accounting series releases – ASR’s and the financial reporting rulings (FRR’s). The other one is the Financial Accounting Standards Board (FASB), which is also involved in the rulemaking of accounting. These are the main organization that is mostly involved in establishment and interpreting of the generally accepted accounting principles ( GAAP) in the United States for both private and public organizations as well as the nonprofit companies.
- Explain the importance of notes to the Financial Statements
Notes to financial statements are mostly used in the clarification of the procedures involved in accounting. This, therefore, assures a perfect explanation of the inconsistencies and the irregularities that could have spotted in the records. They also offer extra information that explains how the organization settled at a certain figure. It reports the additional information and details left out from the main financial document (Penman, 2013). The notes carry essential information regarding the accounting mythologies applied in recording and giving reports of the transactions.
- What are the intangible factors that are important in evaluating a company’s financial position and performance but are not available in the annual report?
The intangible factors essential in the evaluation of the company’s performance and financial position though not provided in the annual report, includes; relation of the management with their employees. Employees are known to be the pivot and insider customers of a company. It is through them that the objectives are actualized. Therefore, if the relationship between the employees and management is at stake, it is likely to pose adverse effects on the performance and the financial position of the organization (Richardson & Wysocki, 2010). Another factor is goodwill. It serves the organizations long term intangible asset that always indicate the image held by the organization in the market and at the front of the investors and stakeholders. The other factor is the effectiveness of management. There should always be appropriate controls for efficient and effective operations in the organization. This can be possible if only the management implements fair rules and regulations for every task carried out in the organization. These are some of the essential intangible factors for the success of a company, although not covered under the annual report.
- Explain how the credit analyst’s focus will differ from the investment analyst’s focus.
The credit analysts have their focus mainly directed to the assessment of the creditworthiness of a loan applicant. This is within the scope of their position as they are required to collect the most relevant information depending on the data and recommend an action plan for the application of the credit. Therefore the analyst is expected to make a recommendation, which includes the extension of the credit line, denying credit, limiting the credit, or closing the account of an applicant. On the other hand, investment analyst focus is directed into a large scale research (Richardson, & Wysocki, 2010). They are expected to research on microeconomic and macroeconomic conditions which are within the bounds of potential business, sector, and industry decisions. Investment analysts should be aware of the conditions to specialize in and, at the same time, build financial models to predict the conditions of the future.
- What are the limitations of financial ratios?
The analysis of financial statements by the use of ratios is highly essential as it highlights the existing relationship between various items in the financial statements. However, it is associated with many limitations. In this, ratios are mainly based on the accounting figure of financial statements, and accounting figures are subject to approximations, deficiencies, and manipulation (Fraser and Ormiston, 2016). Therefore, ratios are not effective for concluding. Ratios are also associated with a challenge of inherent comparability. This means companies utilize varied methods of accounting, which may cause problems, especially when comparing some essential relationships. Other limitations of ratios may include limitation by inflation, and the application varied methods of computations by organizations hence influencing utilization of ratios.
- What do liquidity ratios measure? Activity ratios? Leverage ratios? Profitability ratios? Market Ratios?
Liquidity Ratio
Liquidity ratios are used in the analysis of financial statements to measure the ability of the company to meet its current liabilities. It helps in measuring the capability of an organization to successfully meet the short – term liabilities by using short-term assets.
Activity Ratios
The activity ratio is applied to measure the use of an asset by a company and to determine whether the process of running its operations are efficient. It includes the calculations of indicators that help in making the decision a conclusion on how a firm utilized its inventories, fixed assets, and account receivables.
Leverage ratios
These ratios are used in measuring the value of equity within a company through the analysis of its total picture of debts. The ratios, therefore, help in comparing equity or debt to the assets and the outstanding shares to provide the measurement of the true value of the business equity.
Profitability Ratios
These are financial metrics utilized by the investors and the analysts in measuring and evaluating the capacity of a company to create more profits relative to the revenue, operation costs, balance sheet assets and the equity of the shareholders within a specified period. They are indicators of how an organization makes use of its assets to generate value and profit for the shareholders.
Market Ratios
These ratios are applied in accounting and finance to evaluate the current share price of a company stock that is publicly held. They are mainly utilized by the potential and current investors to help in determining whether company shares are under-priced or over-priced.
References
Fraser and Ormiston (2016). Understanding Financial Statements. 11/edition. ISBN#978-0-13-387403-7
Penman, S. H. (2013). Financial statement analysis and security valuation. McGraw-Hill.
Richardson, S., Tuna, I., & Wysocki, P. (2010). Accounting anomalies and fundamental analysis: A review of recent research advances. Journal of Accounting and Economics, 50(2-3), 410-454.