Accounting Statements and Ratio Analysis
1. Workshop Plan
Aims of the session:
To introduce the three main financial statements
To evaluate how the financial statements are linked
To evaluate the information provided by the financial statements
To investigate how to undertake financial analysis and interpretation of accounts
Essential reading reference:
Chapter 3, McLaney
2. Introduction to the Workshop
This workshop provides a brief introduction to the subject of financial accounting that can assist in making financial assessments of organisations. Financial performance, reliability and stability are all important aspects to consider.
The financial statements most readily available are: the balance sheet the income and expenditure account (also known as the income statement or profit and loss account). the cash flow statement
These will each be examined in turn, after we have briefly considered the function and objectives of financial accounting.

3. The Objectives of Financial Accounting
‘Accounting is the process of identifying, measuring, and communicating economic information about an organisation or other entity, in order to permit informed judgements and decisions by users of accounting information’.
American Accounting Association, A statement of basic accounting theory (Evanston, IL: American Accounting Association, 1966, p.1)
‘The objective of financial statements is to provide information about the reporting entity’s financial performance and financial position that is useful to a wide range of users for assessing the stewardship of the entity’s management and for making economic decisions’
(Statement of Principles 1999)
Financial Accounting:
‘That part of the accounting system that tries to meet the needs of the various external user groups. This it does by means of an annual report which usually takes the form of a balance sheet, income statement and cash flow statement.’
(Berry, 1999)
Users of financial accounting information:
Owners/shareholders
Lenders
Suppliers
Customers
Employees
Government and agencies
General Public
‘The objective of financial statements can usually be met by focusing exclusively upon the needs of present and potential investors’ (Statement of Principles).
4. The Balance Sheet
The balance sheet provides information on an organisation’s assets and liabilities that are capable of being measured in monetary terms, at a particular point in time. This begs the question what is an asset and what is a liability.
Asset – something that brings a future benefit to an organisation.
Liability – what the organisation owes.
Assets
Assets are held for one of two purposes. to be used or converted into cash. to bring in a future benefit in the long term
The first form of asset that is held to be converted into cash is called a current asset. This is something that is held in the form of cash or something that is readily turned into cash, or consumed in some way. Examples of current assets are: cash at bank money due from users of the service (known as receivables or debtors) consumables held in stock e.g. food, medicines etc. (known as inventory or stock) amounts paid in advance for services etc. known as prepayments
The second category, those that bring in a future benefit in the long term are called non-current assets and in some cases fixed assets.
An example of a non current fixed asset could be a minibus, bought with the intention of providing a service for some time into the future. A new computer could fall into the same category. Most fixed assets are used up over time. The cost of their acquisition becomes an expense over their useful life. This expense is called depreciation. It is important to remember that in order to assess the amount of depreciation that should be charged you need to estimate the useful life, what it will be worth at the end of its life and the cost – none of these is necessarily straightforward.
Example 1
Imagine that a