Financial Reporting and Financial Analysis

Financial reporting is the process of producing and presenting financial information to the financial statement users. The production and reporting of financial information require a certain order and a set of rules. International Financial Reporting Standards (IFRS) has become the basis for production and reporting of the financial information in the world and in our country

The financial statements that businesses prepare are as follows; • Statement of financial position (Balance sheet), • Income Statement (statement of profit and loss and other comprehensive income for the period), • Statement of changes in equity, • Statement of cash flows, • And notes, comprising a summary of significant accounting policies and other explanatory information

in Turkey, the Public Oversight, Accounting and Auditing Standards Authority (POA/KGK) is responsible for setting financial reporting and auditing standards for public companies.

Relevancy represents the capacity of the information making a difference in decision making. Second characteristic of faithful representation demands financial information to be complete, neutral, and free of error. Relevance and faithful representation are the fundamental characteristics of useful information.

Financial statements are the final product of the financial accounting process. Financial statements contain the communicated information to the financial statement users. This information is related to the current financial position and historical financial performance of the business. Businesses present this information with 4 basic financial statements and their footnotes; 

Statement of financial position (Balancesheet); Income Statement; Statement of changes in equity and Statement of cash flows

Statement of financial position (Balance sheet) shows assets, liabilities and equity of a company as of a specific date. Total assets of a business are equal to total liability and equity. Assets represent the current and non-current investment totals of the business. Businesses finance these investments with funds received from business owners (equity) or funds received from creditors (liabilities).

In report format, assets, liabilities and equity are listed vertically. On the other hand, account format presentation looks like a T account. On the left side of T account, assets are presented. On the right side, both liabilities and equity are presented. In Turkey public companies present their statements by using report format statements.

Income statement presents the performance of a business by summarizing the income of a business in a certain period and the expenses it incurred to earn those income. In the relevant period, if total income is higher than total expenses, net profit occurs, if less, net loss occurs.

Operating profit is an indicator of how well the business operations are managed. It is the difference between the net sales and all operating costs and expenses. And the bottom line is called the net income. It represents the overall profitability and comprises all income and expense items.

In the direct method, cash flow from operating activities is prepared to show the major collections and payments of the business.

These major collections and payments are; • Collection from customers • Payment to suppliers • Payment for expenses • Payment for taxes

Equity represents the difference between total assets and the total liabilities. It is the book value of the firms’ wealth. But this amount does not represent the true value of the firm. That is due to two main factors. Firstly, all assets and liabilities are not reported at their fair values. Secondly, there could be some items that are not presented in a statement of financial position due to financial reporting standards. Although equity does not show the true value of the business, it is still an important indicator.

Statement of Changes in Equity provides information on the following transactions that caused changes in the company’s equity;

a. Contributions from and distributions to shareholders

b. Income earned and retained in the company

c. Comprehensive income and expenses

d. Transfers among the equity accounts

Decision makers who use business information for different purposes often examine the results of financial analysis that will help them make the following evaluations; • Effectiveness and efficiency of business activities • Current and potential profitability of businesses • Short-term liquidity of the business and long-term solvency

According to the purpose of financial analysis, it is divided into three as management, credit and investment analysis. Credit and investment analysis are usually done within the framework of external analysis, while management analysis is performed within the scope of internal analysis.

Credit analysis is simply the determination of a business’s credibility (creditworthiness). Credibility is a measurement of an enterprise’s capacity to fulfill its obligations. Credit analysis is carried out to determine the liquidity and solvency of a business. While liquidity shows the capacity of an enterprise to meet its short-term liabilities, solvency is the capacity to meet long-term liabilities.

Dynamic analysis examines the relationship between the financial information of multiple successive periods.Dynamic analysis results provide a basis for future forecasts. Dynamic analysis allows the comparison of financial information of an enterprise with other companies as well as comparison with past results

Horizontal analysis is the comparison of an entity’s statement of financial position, income statement and cash flow statement by periods. This comparison can be done in two different ways; a. Comparative financial statement analysis b. Trend analysis

Financial ratios can be classified into four groups. These are; a. Liquidity ratios b. Financial structure (Solvency) ratios c. Activity ratios d. Profitability ratios

Liquidity ratios are the ratios that are used to measure the ability of the enterprise to pay its short-term debts. This analysis helps to evaluate whether the entity has sufficient current assets to meet the short-term liabilities. A more useful liquidity analysis requires the use of activity ratios together.

Financial structure (Solvency) ratios are also called leverage ratios. Financial structure (Solvency) ratios attempt to measure the long-term debt payment ability and sustainability of the business. Financial structure ratios are indicators of the extent to which businesses want to finance their long-term investments with debt and equity.

A successful financial statement analysis depends on certain conditions. These are; • Preparation of financial statements in accordance with financial reporting statements, accuracy of the information in the report (not being manipulated) • Financial analyst’s knowledge of the preparation of financial statements, features and transactions of the business • Correctly determining the impact of the economic and political environment concerning the business on the business activities