Get Your Free Report
CALL US AT: 905 943 4046
"WE GUARANTEE OUR FIXED PRICE QUOTATIONS"
Interpretation of financial statements- Chartered accountants interpret financial statements by various means. Probably the most common technique is to compare each line item on the balance sheet and income statement to the previous year, both in absolute dollars and percent change. The assumption is that the prior year has already been evaluated, and now forms a benchmark against which comparisons can be made. For example, if prior year sales were $5 million and current year sales are $4.5 million, then sales in the current year have declined by 10%, which raises questions as to the reason for the decline. A Chartered Accountant will have investigated and determined that the reason is either increased competition, economic influences on the marketplace, delay in introduction of new products, etc. Another technique for interpretation of financial statements is ratio analysis, which means that the ratio of two line items is calculated and compared to prior year. An example is the current ratio, the term used for current assets divided by current liabilities. The traditional acceptable ratio is 2:1, meaning that current assets are double the amount of current liabilities. This is certainly considered to be a ratio that would please bankers or investors, since it indicates good liquidity for the company. When compared to the prior year’s current ratio, it is necessary to investigate the reason for the increase or decrease in the ratio. This helps to interpret the overall performance of the company and its progress in the current year versus the prior year.
Liquidity- The ability to convert an asset to cash in a relatively short period of time. Assets are classified on the balance sheet in order of liquidity, with bank accounts and short-term investments first, followed by loans receivable, equipment, buildings and other fixed assets.
Working capital- Working capital of a company is defined as current assets less current liabilities. The working capital ratio, which is current assets divided by current liabilities, is considered an indication of the company’s liquidity. A ratio of 2 to 1 is considered very favourable, but this ratio alone should not be considered an adequate means of determining the creditworthiness of a company, without taking into account numerous other factors.