Part one
The fundamentals of business finance
Financial statements are like the tip of an iceberg: underneath the visible part are a lot of record-keeping, accounting methods and reporting decisions. The managers of a business, the investors in a business and the lenders to a business need a firm grasp on these accounting reports so they will know how to recognize both the good and bad signals.
Accountants prepare three primary financial statements. The profit and loss account (income statement in the United States) reports the profit-making activities of the business and how much profit or loss the business made. The balance sheet reports the financial situation and position of the business in terms of its assets and liabilities at a point in time and usually the last day of the profit period. The cash flow statement reports how much cash was actually realized from profit and other sources of cash, and what the business did with this money. In short, the financial life of a business and its prospects for success or danger of failing are all revealed in its financial statements.
The way in which accounting information is recorded and reported is regulated by statutory bodies and the accounting profession. Auditors, amongst other responsibilities, have a duty to ensure these rules are followed and the accounts represent a true and fair picture of the enterprise for the period under consideration. The way in which accounting information is analysed involves the use of a standard range of business tools and ratios that can be applied across all types of venture, so providing some common yardstick.
The final section of this part is concerned with the specific ways in which accounting information can help managers add value to the business by, amongst other things, ensuring profitability is achieved quickly and that all investments are at least planned so as to improve the venture’s profitability.
1
Financial business reports
- The bookkeeping process
- Cash flow forecasts and statements
- Calculating profit
- Balancing the books
Accounting is the process of recording and analysing transactions that involve events that can be assigned a monetary value. By definition financial information can only be a partial picture of the performance of an enterprise. People, arguably a business’s most valuable asset, don’t appear anywhere in the accounts, except for football clubs and the like where people are the subject of a transaction.
Although accounting has become more complex, involving ever more regulations, and has moved from visible records written in books to key strokes in a software program, the purpose is the same; to establish:
- what a business owns by way of assets;
- what a business owes by way of liabilities;
- the profitability, or otherwise, at certain time intervals, and how that profit was achieved.
An MBA in Finance is unlikely to be required to perform the recording side of the accounting process, except in the very smallest of organizations, or if the venture is his or her own. But it is only by knowing how accounts are prepared and the rules governing the categorizing of assets and liabilities (more on this in Chapter 2) that they can gain a good understanding of what the figures really mean. For example, it is not obvious to the uninitiated that a company’s shares are classed as a liability and it is extremely unlikely that the assets as recorded will realize anything like the figures shown in the accounts, audited or not. Bear Stearns, an 85-year-old in...