Day 2

Financial Accounting
Fundamental Accounting Principles
Financial Accounting focuses on gathering, summarising, and
reporting a company’s financial transactions to convey a firm’s
financial position to external stakeholders.
Accrual Principle Going Concern
Revenues and expenses are Financial statements assume
recorded when earned or the business will continue
incurred, not necessarily operating into the foreseeable
during cash exchanges. future.
Consistency Materiality
Use the same accounting Material transactions that
methods from one period to influence stakeholder decisions
the next, ensuring must be reported. Minor items
comparability over time. may be aggregated or omitted.

Accounting Equation
Double-entry Bookkeeping is a system that ensures that every
financial transaction affects at least two accounts. This system
keeps the accounting equation in balance:

Assets = Liabilities + Equity

Resources owned Ownership stake

by the company for Obligations owed by of shareholders
future economic the company to or other
benefits. external parties (to investors.
be settled over time)

The relationship between a company’s assets, liabilities, & equity

is used to evaluate solvency, liquidity, and overall financial health.

Namisha Ostwal 1
Income Statement/ Profit & Loss Statement (P&L)
Income Statement shows how much revenue a company
generates, what it spends, and the resulting profit (or loss) over a
specific period (e.g., a quarter or year).
Net Sales: income from selling products/ services
COGS: Direct costs tied to producing goods/services
Operating Expenses: These include overhead costs.
Net Income: Positive net income signals profitability, while
negative net income signals loss.
Comparing the Income Statement over multiple periods helps
identify trends in revenue growth, cost control, and overall
profitability.

Balance Sheet
The Balance Sheet lists assets, liabilities, and equity and provides
a snapshot of the company’s financial position at a specific time.
Evaluating the Balance Sheet helps stakeholders gauge liquidity
(the firm’s ability to meet short-term obligations) and solvency
(long-term financial stability).

Cash Flow Statement

The Cash Flow Statement offers insight into the company’s
actual cash movements. It breaks down cash inflows and
outflows into three categories:
[Link] Activities: Cash generated or spent in the course
of the company’s core business operations. Positive cash
flow typically signals a healthy, self-sustaining business.
[Link] Activities: Cash used for acquiring or disposing of
long-term assets, such as purchasing equipment or selling
investments. This section reflects strategic decisions about
expansion or asset management.

Namisha Ostwal 2
 3. Financing Activities: Cash received from issuing shares or
borrowing money, and cash paid out to repay loans, buy
back shares, or distribute dividends. This reveals how the
company funds its growth and returns value to
shareholders.
Even a profitable company can run into trouble if it doesn’t
manage its cash properly. Cash Flow Statement helps pinpoint
where cash is coming from and going to, highlighting any red
flags like consistent negative operating cash flow or heavy
reliance on financing.

Interrelation of Statements
Net Income from the Income Statement influences Retained
Earnings on the Balance Sheet.
Changes in Cash on the Statement of Cash Flows tie back to
the Cash line item on the Balance Sheet.
Non-cash expenses (like depreciation) appear on the Income
Statement but also affect the Cash Flow Statement (added as
adjustments when calculating cash from operating activities).

Financial Ratios
Liquidity Ratios
They measure a company’s ability to meet short-term obligations.
Current Ratio: Current Assets
Current Liabilities
It shows whether a firm can cover its short-term debt with its
short-term assets.
Quick Ratio: Cash+Marketable Securities+Accounts Receivable
Current Liabilities
It shows how easily a firm can meet immediate obligations using
the most liquid assets.

Namisha Ostwal
3
Profitability Ratios
They assess how effectively a company generates earnings
relative to sales, assets, or equity.
Gross Margin: Revenue – COGS
Revenue
It shows the percentage of revenue retained after accounting for
direct production costs.
Operating Margin: Operating Income
Revenue
It shows the percentage of revenue left after covering operating
expenses like salaries, rent, and R&D.
Net Profit Margin: Net Income
Revenue
It shows the percentage of revenue retained after accounting for
direct production costs.
Return on Equity (ROE): Net Income
Average Shareholders’ Equity
It shows how effectively a company uses shareholder
investments to generate profit.
Leverage Ratios
They highlight how much debt a company uses relative to its
equity or assets, indicating potential risk.

Debt-to-Equity: Total Liabilities

Total Shareholders’ Equity
It shows the proportion of financing that comes from debt
versus equity.
Debt-to-Assets : Total Liabilities
Total Assets
It shows the percentage of a company’s assets financed by
creditors.

Namisha Ostwal 4
Efficiency Ratios
They evaluate how well a company uses its assets and liabilities
to generate revenue.
Inventory Turnover : COGS
Average Inventory
It shows how quickly a company sells and replaces its inventory.
Receivables Turnover : Revenue
Average Accounts Receivable
It shows a company’s effectiveness in collecting payments.
Asset Turnover: Revenue
Average Total Assets
It shows how effectively a company uses its total assets to
generate revenue.

Market Performance Ratios

They are useful for evaluating publicly traded firms.
Price-to-Earnings (P/E): Market Price per Share
Earnings per Share
It shows how much investors are willing to pay for each dollar of
a company’s earnings.
Earnings per Share (EPS): Net Income – Preferred Dividends
Average Outstanding Shares
It shows the portion of a company’s profit allocated to each
outstanding share.

Red Flags in Financial Statement

·Inconsistent Growth &·Frequent Restatements
·Changes in Accounting Estimates or Policies
·Significant Discrepancies Between Net Income & Cash Flow
·Unusual Transactions or Off-Balance Sheet Items
·Receivables or Inventory Growing Faster Than Sales

Namisha Ostwal 5