There are three main components of financial statement used for financial analysis. They are as follows:

  1. Balance Sheet 
  2. Income Statement 
  3. Cash flow Statement 

(a) Balance Sheet

Balance sheet shows the present statement of a business. The business as a single entity shows the financial condition of an accounting entity as at a particular point in time.
Balance sheet consists of assets (probable future economic benefits obtained and controlled by an entity as a result of past transactions or events). They may be physical assets such as land, buildings, stocks, or inventory. Assets may also be intangible such as trademarks, goodwill, copyright, or patent. For instance, assets are normally categorized into current and long-
term. This will be discussed in detail in subsequent units.

(b) Income Statement

Income statement is otherwise known as profit and loss account. Other scholars refer to it as statement of income, statement of earnings and statement of operations. It is a summary of income
and expenses, gains and losses of a business organisation and ends with the determination of net income for a specific period. Income statement reveals the revenue (income) and expense
(disbursements); hence the profit and loss is expressed with the true position of the net income. Management will have the profitability index and decision will be taken based on this.

The management can ask basic questions like “Can the present profit margin sustain the business?” “Should the business go for borrowing?” “Is the leverage position of the business alright?” “Should the company expand its operations?” “Can the business add to its human resource needs?”

The elements of income statement are:

  1.  Net sales (revenue/income) 
  2. Cost of goods sold or cost of sales 
  3. Other operating revenue 
  4.  Selling expenses 
  5. Administrative expenses 

(c) Cash flow Statement

The analysis of cash flow benefits is for short-term planning with a view to generating enough cash to settle indebtedness maturing in the near future, to pay interest on borrowing and other
expenses and to pay dividends to shareholders. The enterprises can make projects of cash inflows and outflows for the near future to determine the availability of cash. This cash balance can be matched with the needs of the business for the period and appropriate arrangement can be put in place to meet deficit or invest surplus cash temporarily. It should be noted that a historical analysis of cash flow provides an insight for the preparation of reliable cash projection for the immediate future.

On the other hand, the cash statement enables management to explain the changes in cash and cash equivalent production. Management can use cash flow statement for dividend posting, cash generated by operations, investing and financing policy.

Basic elements of cash flow include the following:

  1. Operating Activities: consist of all transactions plus other events that are not investing or financing activities. Cash flows from operating activities are generally the cash effects of transactions and other events that are added to determine the net income. 
  2. Investing Activities: consist of lending money and collection of these loans and acquiring and selling investments and productive long-term assets.
  3.  Financing Activities: consist of cash flows relating to liability and owners’ equity. 

The details of these cash flow activities will be expressed in subsequent units with illustration to back them up.

3.3 Financial Statement as a Management Tool

Financial statement helps in presenting the financial to oversee the resources of the information and data of an organization. The statement will be meaningless if they are not appropriately utilized.

Users of financial statement include managers of business, financial analysts, consultants, researchers, trade creditors, suppliers of long-term debt, bankers, investors, etc. In this course, we will concentrate on its usefulness to management as a tool for decision making.
It is the overall responsibility of management to oversee the resources of the enterprise. Financial statement presents the accounting reports with dependable financial information to guide and aid management in evaluating the performance of the business outfit. This is done through the interpretation and analysis of the financial statement, either directly or through consulting experts, within or outside the management circle.

The financial statement properly prepared forms the basis for financial planning by management. The management will, at the end, take appropriate decision on how to run the business efficiently and effectively. Financial statement analysis helps management predict, compare and evaluate the enterprise’s activities and forecast the earning ability of the enterprise. It is the financial statement analysis that will direct management on the financial condition of the enterprise as well as the statement of affairs of the enterprise at a particular moment in time.

It should be noted that in modern management, the head of financial management belongs to the management team and is always a reference point of the top management on financial issues. His/her expertise is always sort before a financial decision is made. If this is ignored, the management will not have the true and fair picture of financial position and consequence is always a negative one.
With the balance sheet, the financial position of the assets and liabilities is known and management will always be informed. Hence, it is worth of note that financial statement position and its analysis/interpretation would enable management to respond to the challenges posed by this analysis appropriately.

Self Assessment Exercise 2

Discuss financial statement analysis as a tool for management decision making.

4.0 CONCLUSION

We hereby conclude that the financial statement is a record of financial activities of an organization which is used for financial analysis. When properly analyzed and utilised by management it can turn out to be a guide to the growth and development of the enterprise.

5.0 SUMMARY

In this unit, we have taken a brief overview of financial statement analysis, alongside the main components like balance sheet, income statement and cash flow statement. The unit concludes with the discussion of financial statement analysis as a tool for management decision making.

6.0 TUTOR MARKED ASSIGNMENT

  1. Identify the main components of financial analysis. 
  2. Discuss financial statement analysis as a tool for management decision

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MAIN COMPONENTS OF FINANCIAL STATEMENT

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