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Assignment 2: Discussion—Understanding Financial Statements
In this assignment, you will learn to read and interpret financial statements. Understanding the four financial statements provided in the lectures and reading for this week and dealing with a company’s financial performance is critical to making decisions about its management and its relation to the global economy and financial markets.
Put the following income statement and balance sheet terms (general ledger accounts) in the proper order for properly prepared financial statements:
Taxes, interest, gross profit, selling, general and administrative expenses, sales, depreciation, net income, cost of goods sold, EBITDA.
Put the following balance sheet terms (general ledger accounts) in the appropriate category as either short-term assets, long-term assets, short-term liabilities, long-term liabilities, and/or owner’s equity for properly prepared financial statements:
Cash, accounts payable, accruals, property, plant and equipment, inventory, accounts receivables, paid in capital, retained earnings, notes payable, mortgage, accounts payable.
In terms of McGladrey and Pullen’s Reading & understanding financial statements: A guide to financial reporting, explain the balance sheet equation
Cost of goods sold
Selling, general and administrative expense
Short-term assets: Inventory, accounts receivable, cash.
Long-term assets: Property, plant and equipment,
Short-term liabilities: Accounts payable, notes payable, accruals.
Long-term liabilities: Mortgage.
Owner’s equity: Pain-in capital, retained earnings.
The balance sheet incorporates the three-vital aspect of a business, namely asset, liability and equity, to provide users with a complete overview of the Company’s net worth as at a certain point in time. All the transactions that a business goes through are recorded in general ledgers and the remaining balance at the year-end are transferred to the balance sheet as either an asset, liability or equity. Hence any transaction will eventually be translated to one of the three categories on the balance sheet (Ward, 2017).
The first category on the balance sheet is the asset. This includes both long-term and short-term assets and provides the user information relating to the tangible and intangible resources that is utilized by the company to operate and turn a profit (Riggs, 2007). The long-term assets represent financial resources to be utilized by the company over a long period of time and therefore, these will not be converted into cash but rather depreciated over their useful lives. Some of the long-term assets include freehold land, plant and equipment etc. The short-term assets represent assets which will be converted into cash or other financial assets within the financial year and includes items such as inventory which is subsequently converted into accounts receivable and finally into cash. The cash balance of a company is highly sensitive and requires constant monitoring for the company’s overall financial health (Newhouse, 2010).
The liabilities section allows the user to observe items that the company owes to various vendors of the company. The long-term liabilities represent loans and other long-term commitments made by the company and are usually used to finance long-term business assets or financing for new business projects. The short-term liabilities represent the amount owed by the company to various operational vendors which need to be cleared in less than one years time. This includes trade payables, rent accruals etc. (Newhouse, 2010).
The final section is the owner’s equity. This represents the portion that the shareholders of the company own. In summary, this includes the initial investment paid-in by the owners represented by the paid-up capital amount and also includes the retained earnings amount which represents the overall profit remaining within the business after the owners have taken out their dividends (Riggs, 2007).
Overall, the above three sections make up the equation “Asset = Capital + Liability”, which is what the balance sheet represents.
Newhouse, C. (2010). “Understanding the Balance Sheet” ABC Amega. Retrieved from URLhttp://www.abc-amega.com/articles/credit-management/understanding-the-balance-sheet
Riggs, H. E. (2007). “Understanding the financial score” San Rafael, Calif.: Morgan & Claypool Publishers.
Ward, S. (2017). “Balance Sheet Definition and Examples” The Balance. Retrieved from URLhttps://www.thebalance.com/balance-sheet-definition-2946947
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