It is stated in the law that all businesses in operation must keep their financial as well as their accounting records in a reliable way so that they can provide an accurate view of the business and its operations. The internal Revenue Code 6001 requires all businesses to keep records which are appropriate to the kind of business that they are undertaking and the Internal Revenue Code Section 6001 (IRS) has the authority and the right to go through the records at the time that they want to audit firms tax return. In case the results received are not favorable or are not liked by the IRS, the business is likely to incur penalties which can reflect negatively to the business as well as the owners personal life. It is also very important for firms to keep their financial and accounting records not just for auditing purposes but for the business’s benefit because without the records, the business is likely to lose deductions and they may end up having little control over the amount of money that they make or lose in the firm.
Financial and accounting records for evaluating firms
There are various financial and accounting records which a person can use to evaluate the firm so as to check how their operations are, that is whether they are making profits or losses so that measures can be taken to ensure that their operations are profitable.
A balance sheet is a financial statement which shows how a business gets funded in capital and reserve by the capital invested by the owners and the current trading profits and also shows how the funds are currently used by the firm that is stock, building, debtors and cash among others. The major sections of a balance sheet are assets, liabilities and capital or reserves.
The balance sheet shows assets, which the business has and they are classified as either fixed or current assets. The current assets can easily be converted into cash and they include the cash at hand and bank, the accounts receivables, notes receivables, marketable securities, inventory, short term investments and any prepaid assets such as insurance. The fixed assets of a business are classified into tangible assets such as land, building, and equipments such as machinery, fixtures and fittings and the intangible ones are goodwill, licenses, patents, trademarks and development costs and their costs are usually lower that the market costs.
Liabilities represents the portion of the business assets which are owned by the creditors and they are classified in the short term or current assets and longterm or non-current assets. The current liabilities are such as the trade creditors, short-term bank loans, accounts payable, interest payable, notes payable, wages, taxes payable and any financial commitments due under one year duration, while the non-current liabilities are the mortgages and the bond payable.
The capital or reserve shows the amount of wealth which is owned by the business at any given time. There is owners equity in the case of a sole proprietorship or a partnership and shareholders equity in the case of a corporation and the equity owners are the residual claimants and are paid after creditors. The balance sheet therefore is clearly useful during a firm’s evaluation as it shows the resources available and they show the ability of a company in meeting its long term obligations and the comparative balance sheets most useful during evaluation. When the assets of the company have a high value and the liabilities are low, then the company is financially stable, the stability is also seen in companies with a strong capital otherwise if the liabilities are high then the company may not be able to meet its financial obligations (Seidman, 2004).
The income statement of a business shows the results of the business operations during a certain period such as an year or a month depending on the time when a business carries out its financial analysis. The equation which is used to show the income of the business is:
Net income= revenue -expenses.
The revenue of a business refers to inflows from manufactures of a product or delivery from a rendering service while expenses shows the outflows which are incurred so that the business can get revenue from its operations. Gains of the business are such as capital gains while loses are like capital losses which can be experienced from natural disasters. The income statements would therefore help in evaluation of the firm so as to know how much profits they are able to make in a certain period and therefore design ways of increasing the profits and minimizing the costs. When the company revenues are high and expenses are low, it means that the company has a stable financial base and will be able to pay off its debts.
Statement of Owners’ Equity
Equity statements shows the changes which occur in the retained earning which appear in the balance sheet and they are mostly influenced by the dividends and incomes of the business. The retained earnings statements usually uses information from the statement of income and then provides that information to the balance sheet of the firm. In the case of a sole proprietorship, the equity is gained by:
- Ending equity= beginning equity=investments-withdrawals+income
In corporations, the stockholders equity is got from:
- Stockholders equity= premium on common stock+preferred stock+premium on preferred stock+retained earnings.
When a company’s liabilities exceeds its assets, it means that it will not be able to pay for its debts and therefore the company will be insolvent. More retained earnings shows a better financial base and company solvency.
Cash Flow Statement
The cash flow or accrual accounting shows that a company may be profitable but at the same time experience cash shortages. The cash flow statement is very useful in evaluation of a business’s ability to pay bills which have been incurred by the firm for given period of time. The statement usually shows the sources of cash for the business, the uses of the cash available and the changes experienced in the cash balance. The cash flow statement is a representation of the analysis of all business transactions from where it obtained cash and how the cash was used. The sources and uses are categorized into operating activities, investing , and financing activities and the information is derived from the balance sheet and income statement of that period (Ittelson, 1998). If there is a negative cash flow, the company will not be able to pay its debts in time therefor it will be insolvent, positive cash flow shows ability to pay debts therefore more solvent.
There are various financial ratios which a company can also use in determining its solvency, these ratios are found in the financial statements. The leverage ratio is found in the profit and loss account and shows the extent that debt is used in the capital structure, the more the debt the higher the insolvency. The liquidity ratios shows the company’s ability to pay its short term debts, if the ratio is high the higher the margin of safety which the company has in its ability to pay off its short term debts, these ratios are such as current ratios, quick ratios and operation cash flow ratios. Solvency ratios give a picture of the ability of the company to generate cash flow and its ability to pay its long term financial obligations, it measures size of after tax income and how it will continue meeting debt obligations and if the ratio is greater than 20%, the company is said to be healthy and if the ratio is low, then the company be default in paying its debts.
There are various economic trends which a person can use in predicting the success or failures of a firm in the near future. The trends which dictates the economic status of a firm are such as the prices of products in the market, the labor market, the demand and the output indicators, financial statistics, the productivity of the business, the visible as well as the invisible trade balances, earnings and final expenditure and price indexes.
The consumer spending is one of the economic trends which can determine success or failure of a business in the near future. This deals with the analysis of how the consumer demands for the firms products are fairing in the market. One can determine the level of demand by looking at the amount of real disposable income available to consumers for purchasing the firms products, the real consumption which takes place, the retail sales of products and the debt service payment. If the available disposable income is at a raise, and the consumers are spending more, then the business will have more finances and more solvent but if the disposable income is on the decline so will be the consumption and the firm may fail due to lack of demand for its products and may become insolvent (Sloman, 2004).
Another economic trend is the changes in prices of products in the market. One should look at the trends of the consumer prices for goods, the producer prices for raw materials to be used in the firms, the cost of employment, and the compensation per hour as well as the consumption price. A business can be successful in the future if the consumers price for the goods that it produces are on the rise while the producer prices for the raw materials is decreasing because it means that the firm will have a higher revenue and therefore more solvent. If the consumer prices are decreasing and the cost of production increasing, it means that the firm will have a narrow revenue which may lead to the firm’s failure because it may be unable to meet its debts and therefore become insolvent.
The third economic trend is the general economic growth of the country in which the firm is located. If there is a positive economic trend where the economy is growing in all the sectors and industries such as agriculture, service sector and production sector and the poverty rates are decreasing, then the business will be successful in the future and will have better finances for paying off the debts, however, if there is a downward trend where the sectors are performing poorly and the poverty rate are on the rise, then the firm is likely to have poor performance in the future since people are nor purchasing and may therefore be insolvent. (Pratt, Reilly & Schweihs, 2000).
The fourth economic trend which can determine the success or failure of a firm is the productivity and profit trends of the firm. The trends are determined by the output per hour compensation, non-firm compensation and profits received in the company and the output level. A firm is likely to be successful in the future if its production base is strong where it is able to meet all the demands at a low price and and also meet its financial obligations. However, if there is a continued raise in labor costs and the firm is unable to meet the production level required in the firm, it is likely to fail in the future due to lack of enough profit flow into the firm which facilitates successful running of the company (Pratt, Reilly & Schweihs, 2000).
Legal questions to ask hiring executives
There are a lot of questions which a candidate for a job and especially a job related to the financial and accounting departments of a firm can asked the hiring executives who are interviewing him or her.
The legal questions are such as; What level of education and experience do you require for this position? Another legal question which may be asked is; are there certificates and licenses needed of me for the position?, Does the position require me to work for overtime? What procedures are followed in ensuring a good financial system for the company? Will I be needed to file a financial disclosure state? (Kador, 2002).
In conclusion, businesses need to keep up to date financial and accounting records so that they can be able to follow up how the business is fairing and therefore work towards success and correct any trend which may lead to the failure of the business. The records helps the business to know its economic status and they should be constantly reviewed so that the business can survive.
Ittelson, T. R., (1998), financial statements: A step-by -step guide to understanding and creating financial reports, United States.
Kador, J., (2002), 200 questions job candidates may ask your company, McGraw-Hill Companies.
Pratt, S; Reilly, R.F. & Schweihs, R.P., (2002), Valuing a business, United States. McGraw-Hill professional.
Seidman, K. F., (2004), economic development finance, United States SAGE.
Sloman, J., (2004), The economic environment of business, Financial Times Prentice hall.