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The preparation and interpretation of financial statements are keystones to the financial health analysis of a business. Financial statements therefore become very important in communicating the performance, financial position, and cash flows of an organization. This is how to prepare and interpret them effectively.
Preparing Financial Statements
Gather Financial Data:
Gather all financial records: sales records, purchase records, bank statements, and expense receipts.
Choose one form of the accounting method:
Whether to use cash basis or accrual basis accounting. The accrual basis is used by most businesses in the UAE because it more accurately matches revenues and expenses.
Prepare the Statement of Profit and Loss:
Revenue: Total sales or income from operation
Expenses: Cost of goods sold, operating, and non-operating expenses
Net Income: Revenue less expenses
Prepare Statement of Financial Position
Assets: Current Assets, like cash or accounts receivables, and Non-Current Assets, such as property or equipment.
Liabilities: Current liabilities, such as accounts payables, and long-term liabilities, including loans.
Equity: Owner's equity or shareholders' equity.
The company should generate adequate cash to meet its liabilities. Five Ways of Analyzing Financial Statements
Horizontal Analysis:
This method compares the financial data of two or more periods to enables the establishment and determination of trends and growth patterns.
Vertical Analysis:
Express each item on the financial statement as a percentage of some base amount, such as sales or total assets.
Ratio Analysis:
Financial ratios, such as liquidity ratios, profitability ratios, and solvency ratios, are used to determine various aspects of financial performance.
Formulae for Financial Statements
Income Statement Formulae:
Net Income: Revenue – Expenses
Gross Profit: Revenue – COGS
Operating income is gross profit less operating expenses
Balance Sheet Formulae;
Assets = Liabilities + Equity
Current Ratio = Current Assets / Current Liabilities
Debt to Equity Ratio = Total Liabilities / Total Equity
Cash Flow Statement Formulae;
Operating Cash Flow = Net Income + Non-Cash Expenses + Changes in Working Capital
Investing Cash Flow = Cash Inflows from Sale of Assets - Cash Outflows for Purchase of Assets
Financing Cash Flow: Cash Inflows from Issuing Debt or Equity – Cash Outflows for Debt Repayment and Dividends
Conclusion
These are the reasons any business owner or financial professional needs to develop skills in preparing and interpreting financial statements: Use of different methods and tools for analyzing financial data helps in gaining insight into the business's financial health and also drives key future decisions. Formulae and concepts behind financial statements make sure that reporting and analysis are accurate—two things which are preconditions for regulatory compliance and business success in the UAE.
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