Week #5, Blog Entry #5:            Finance Fundamentals

 

This week’s lessons focused on business finance tools to assess business profitability, economic forecasting, resource management, strategic investment, and planning to promote long-term business stability. Just like in medicine, accounting and finance have their own nomenclature and basic concepts that define economic issues that affect businesses and markets. Financial accounting collects data about a business and organizes it in specific standardize formats used by entities outside of the business, such as investors, creditors, and governments (Peterson, 2023). On the other hand, managerial accounting collects data for internal business use, amongst leaders, managers, and employees to help make decisions regarding the business’s operations and future. I will describe here the four basic reporting tools used to assess business health, economic strength, and profitability.

 

Income Statement

The income statement outlines a company’s financial performance over a specific period of time. It provides a sense of business profitability, with details regarding company revenues, expenses, and the resulting net profit or loss (Franklin, 2019). The statement can help evaluate where is the company profit being generated, as well as the ability to see non-recurrent expenses (e.g. litigation and research expenses).

 

Statement of Retained Earnings

The statement of retained earnings records company income generated and retained, after paying expenses and investors, available to be used by the company. Retained earnings usually come derived from the company’s income statement (Franklin, 2019). Many of the retained earnings, which are considered business equity, are used in the future to pay debts or other liabilities, or are reinvested into the companies in equipments or operational improvements.

 

Cash Flow Statement

Cash flow statements capture the movement of cash in a business, both the inflow and outflow of cash through a specific period of time (Irwin, NDP). The statement tracks cash movements by categorizing them into operating, investing, and financing activities. The statement allows us to better understand the movement of monetary resources not recorded in other financial tools. Cash flow is interpreted as a tool that can be helpful in assessing a firm’s financial efficiency recording the company’s net income.

 

Balance Sheet

The business balance sheet is one of the most important financial statements for a business, as it provides a brief overview of the business’s financial position during a specific point in time. It provides a snapshot of the financial health of a business, and is valuable in guiding management decisions to ensure business’s long-term financial stability and profitability (Schmidt, NDP). It is composed of company’s assets, liabilities, and equity helping investors, creditors and business leaders assess the company's financial stability, investments, liquidity, financial leverage, and profits. Company management uses balance sheets to help in budgeting and cost containment, investment decisions, tracking business growth, financial trends, and strategic planning.

 

Ratio Analysis

There are many other financial tools aside from the income statement, statement of retained earnings, cash flow statement, and balance sheet to assess the solvency, financial leverage, profitability, and asset turnover of a company (Irwin, NDP). Many of these tools derived the business information from the four basic financial statements of a company previously described.

 

Other Financial Tools

There are many more financial tools available to assess company financial health. EBITDA = Net Income + Interest + Taxes + Depreciation + Amortization or EBITDA, is a financial metric that measures a company’s profitability before accounting for non-operating expenses like interest, taxes, and non-cash expenses such as depreciation and amortization (Peterson, 2023). It is commonly used to evaluate a company’s operational efficiency and cash flow generation. It is particular useful to compare different companies within the same market sector while eliminating company specific management related recordings found in other financial tools. EBITDA removes differences in capital structure and tax policies. Investors and creditors use this tool to assess the profitability and cash flow potential between companies before considering debt and reinvestment needs. 

 

 

References:

 

Peterson, C. (2023). Lecture Series on Accounting and Financial Statements.   Personal Collection of C. Peterson, University of Illinois Springfield, IL.

 

Franklin, M., el al. (2019, Apr. 11). Principles of Accounting, Volume 1: Financial Accounting. OpenTax, Rice University. https://openstax.org/books/principles-financial-accounting/pages/2-1-describe-the-income-statement-statement-of-owners-equity-balance-sheet-and-statement-of-cash-flows-and-how-they-interrelate

 

McGraw-Hill/Irwin. (ndp). Financial Statements: Analysis and long-term planning. [PowerPoint Slides}. https://uispringfield.instructure.com/courses/15602/files/2351650?wrap=1

 

Schmidt, J. (ndp). Three financial statements. Corporate Finance Institute. Retrieved February 15, 2025.

https://corporatefinanceinstitute.com/resources/accounting/three-financial-statements/

 

 

 


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