Financial Reports
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Your financial report will be the formal record of your venture's financial activities for the year. It should involve your balance sheets (your assets, equity, and liabilities at the time), income statement (also known as your profit & loss, or P&L statement), statement of retained earnings (explaining any changes in your earnings over a period of time, and your cash flow statement (your operating, investing, and financing activities over a period of time).
The International Accountant Standards Board (IASB) defines the purpose or objective of a financial report as "provid[ing] information about the financial position, performance and changes in financial position of an enterprise that is useful to a wide range of users in making economic decisions."[1] It also points out that what will make your financial report most useful to investors, creditors, and yourself will be its understandability, relevance, reliability, and its comparability - both to previous and future financial statements and to those of your competitors. [1]
Your financial report, therefore, should be readable by others without a degree in finance or accountancy. It should also focus particularly on the financial information that is likely to "influenc[e] the economic decisions of users,"[1] and that is as up-to-date as possible. Most importantly, your financial reports should try to stay as free from errors as possible – errors which may come as a result of using too many estimates or uncertainties in your calculations – without sacrificing the relevance of the information.[1]
Terminology
Sometimes the terminology used in financial reports — and more importantly for entrepreneurs, in creating financial reports — can seem pretty daunting for those without a background in finance. Don't feel like this means that you can't run your own business, and certainly don't let it stop you from doing your financial reports! What you should do is try and familiarise yourself with the different terms and what they mean, even if someone else is handling your accountancy. Some of these terms include:
- Assets
- These are your "probable future economic benefits obtained or controlled by an entity as a result of past transactions or events"[2]
- Profit Margins
- There are two different kinds of profit margins that you should consider, your Gross Profit Margin and your Operating Profit Margin. The gross profit margin "expresses gross profit as a percentage of sales. Gross profit is what remains after cost of good sold (or direct costs) are subtracted from revenues."[3]
- Liabilities
- Your 'liabilities' refer to any probable future financial sacrifices that you may need to make as a result of current obligations that you might have "to transfer assets or provide services to other entities in the future as a result of past transactions or events."[2]
- Equity
- Your equity is your venture's net assets, the amount of your assets that remains once you have deducted your liabilities[2]
- Return on Capital (ROC)
- Also known as ROIC - Return on Invested Capital, your ROC is the measurement of your venture's efficiency when it comes to turning total capital into profits[4]
- Price/Earnings Ratio (P/E Ratio)
- Ken Pirok describes the P/E ratio of a venture as "represents the multiple of a stock’s price over its earnings per share," which will be used alongside the earnings per share (EPS - see below) to determine the a venture's stock performance and value [5]
- Earnings per Share (EPS)
- Your earnings per share is widely used in investment analysis, so it is an important one to consider. It will measure your profitability on a per-share basis, and can be, as Pirok describes, "'trailing' using the last twelve months of earnings or 'forward' using projected earnings."[6]
- Return on Assets (ROA)
- Your return on assets represents not only your return on your total assets, but also your net profit margin multiplied by your asset turnover: Pirok advises anyone working on calculating their ROA to keep in mind that "you will generally find an inverse relationship between the two ratios comprising return on assets. A company with a low net profit margin will likely exhibit higher asset turnover and vice versa"[7]
- Return on Equity (ROE)
- Your ROE measures your company's return on total equity — although, as Pirok notes, you may decide to use your average equity in your calculations in order to better adjust for any fluctuations. He goes on to point out that "The ROE formula actually represents ROA times an 'equity multiplier.' This multiplier (the ratio of assets to equity) actually measures leverage. A higher number indicates a greater proportion of debt financing."[8]
Further Reading
Pirok's Financial Statement School offers much more detailed descriptions of these and other important aspects of financial reports, as well as information on understanding their importance and how to properly calculate each.
For a more general guide to accountancy and accountancy terminology, a study guide like those provided at AccountingInfo.com might be more useful. AccountingInfo.com also outlines information about the International Financial Reporting Standards (IFRS) and the US Generally Accepted Accounting Principles (GAAP), which differ from the International Accountant Standards Board (IASB).
For a more detailed perspective on the framework and presentation of Financial Reports as laid out by the IASB, see their website, which offers summaries of International Reporting Standards, including both the "The Framework for the Preparation and Presentation of Financial Statements" and the "IAS 1 - Presentation of Financial Statements"
References
- ↑ 1.0 1.1 1.2 1.3 1.4 The Framework for the Preparation and Presentation of Financial Statements, International Accountant Standards Board [1]
- ↑ 2.0 2.1 2.2 Accounting Study Guide, "Components of Financial Statements: Assets, Liabilities, Owner's Equity, Revenues, Expenses, Gains, Losses," AccountingInfo.com [2]
- ↑ Ken Pirok, Profit Margins, Financial Statement School 08-06-2008 [3]
- ↑ Ken Pirok, Return on Capital (ROC), Financial Statement School 04-03-2009 [4]
- ↑ Ken Pirok, Price/Earnings or P/E Ratio, Financial Statement School 12-25-2008 [5]
- ↑ Ken Pirok, Earnings per Share or "EPS", Financial Statement School 11-10-2008 [6]
- ↑ Ken Pirok, Return on Assets or "ROA", Financial Statement School 9-16-2008 [7]
- ↑ Ken Pirok, Return on Equity or "ROE", Financial Statement School 9-24-2008 [8]
