Financial management is the process of managing the finances of an organization. As a
finance manager, a person plans how to use the financial resources of an organization.
Depending on the situation that the financial resources are inadequate or high, they
manage them accordingly. Another task of financial manager is to decide whether to take
loan or release equity. They can also decide the correct mix of debt and equity such that
they don’t create burden for payment in the future.
Also financial management tries to maximize shareholders wealth through reinvesting
in profitable operations. They retain certain earnings of the company and invest further
in profitable business. They also decide the distribution of dividends to shareholders. They
also manage funds for future payments such as salaries and bills.. Thus they maintain
financial stability and solvency. For this they are helped by financial statements.
Financial statements are the consolidation of all financial happenings in an organization.
It is a summarization of all the business done by an organization, their assets, liabilities and
equities plus their cash flows. There are three types of financial statements namely Income
Statement, Balance Sheet and Cash Flow Statement. Income statement helps to access
efficiency of an organization by checking whether it generates profit or loss. The balance
sheet shows the assets, liability and equity of an organization. It helps to evaluate whether the
assets level can cover its liabilities. Also, it shows the leverage mix of an organization. I.e how
much financing is done by debt and how much by equity. On the other hand, the cash flow
statement shows how much cash a company is generating from operating, investing and
financing activities.
Financial reporting is the act of presenting the financial statements in report format to
managers, stockholders as well as investors.These interested groups use these report to
improve company processes or to ask for dividend or decide for lending. The key
components of financial reporting are the Executive Summary, Financial Statements,
Notes To Financial Statements, Management Discussion And Analysis and Other
Disclosures. All these sections should be duly prepared because it is the duty of financial
manager as per transparency and accountability rules.
Types of Financial Statements
Balance Sheet: Balance sheet can be prepared monthly, quarterly, semi-annually as well
as annually for investors . It highlights financial position of an organization by dividing it into
assets, the liabilities as well as shareholders equity parts. Assets are the properties owned by
the company permanently or temporarily. Liabilities are financial obligations that a company is
legally required to settle, typically through the payment of money, goods, or services.
Shareholders equity reflects the amount of capital the owner invested plus any retained profit
by the company. It is what remains after paying all the liabilities.
What constitutes balance sheet?
Assets: Assets denotes the economic resource which are acquired for economic benefit of
an organization. They are accumulated through shareholders equity or purchased from
profits retained by an organization. They can be tangible such as land, buildings, machineries
or intangible such as goodwill. There are two types of assets namely: Current Assets and
Fixed Assets or Long Term Assets. Current assets are those assets which can be converted
into cash or cash equivalent within a year. Its examples are: Cash, Marketable securities,
Inventories, Receivables and Accruals. On the other hand, Fixed or long term assets are the
ones which can’t be converted into cashor cash equivalent within a year. Its examples are
equipment, buildings, factories, property etc. An organization invests in fixed assets because
they believe it will bring them benefits in the forseeable future.
Liabilities: Liabilities denotes the payables of an organization. It represents every form of
dues which are to be paid in near future or long term future. It can also be said that it is the
claim of outsiders on company’s property. Its examples are loan payable to creditors, salaries
payable to employees etc. Liabilities section of balance sheet can be divided into Current
Liabilities, Long Term Liabilities and Share Capital. Current liabilities are the ones which
are to be paid within a year. For example: Interest on debt, taxes etc. Long term liabilities
are the ones which mature in the period longer than one year. They can represent longer term
loans taken by an organization. Its examples are: Loans that are payable at more than one year,
Pension Obligations etc.
Shareholders Equity: Shareholders' equity represents the share of shareholders in a
company. It represents the amount invested by shareholders plus any profit earned and
retainedby the company. Thus, the right to this properties belong to shareholders. Further,
it can be divided as “Shareholder’s equity on the basis of book value” and “Shareholders
equity on the basis of market value”. Book value refers to the accounting value of an asset
or company as recorded in its financial statements or books of accounts.. Thus, shareholders
equity based onbook value is the value of equity on the basis of accounting records. However,
shareholders' equity based on market value reflects the value of a company's assets as
determined by their current market prices, rather than their recorded book values.
Income Statement: The other name of income statement is profit & loss statement.
It is prepared to understand the profitability of a firm over a certain period (Quarterly,
Semi-annually and annually) . It calculates net income by substracting expenses from
revenue. Expenses can be cost of goods sold, general and administrative expenses,
salaries, advertising, interest expense and taxes. Cost of goods sold refers to the direct
costs associated with the procurement and production of the goods that have been
sold by a company. General and administrative expenses refer to the routine operating
costs and administrative expenses necessary to run the day-to-day operations of a
business. Salaries are monthly costs to be paid to employees. Advertising is the
marketing costs and interest expenses is the cost of debt. Whereas taxes is the cost on
income payable to government.
Its structure is,
Revenue
Cost of goods sold
Gross Profit
Operating expenses
Operating Profit
Other income
Other Expenses
Net Profit Before Tax
Income Tax
Net Profit (Or Net Loss)
This structure clearly shows that to get net profit or net loss, first cost of goods sold is
subtracted from revenue. It gives Gross Profit. Operating expenses, such as salaries and
administrative costs, are subtracted from gross profit to arrive at the operating profit. Now
other incomes are added or other expenses are subtracted to reach Net profit before tax.
Finally income tax is deducted to get Net Profit or Net Loss.
Cash Flow Statement: Cash flow statements show the cash flowing in and out of an
organization. It is divided into “Cash flow from operating activities”, “Cash flow from investing
activities” and “Cash flow from financing activities”. Cash flow from operating activities is the
cash flow from doing business activities. For example: A biscuit factory produces and sells
biscuits, A bank lends money to businesses, and earn from it. Cash flow from investing
activities is the cash flow by investing in long term assets such as land, building and shares
of other companies. For eg: A companies buys land, promoter shares, machineries etc.
Cash flows from financial activities is the cash flow by raising finance through shares or
debt. For example: An organization raises finance through bank loan and issuing promoter
shares.
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