Basic financial statements

There exist three basic financial statements: the income statement, the balance sheet, and the statement of cash flows.

The income statementmeasures the firm’s profitability over a period of time. The firm is able to choose the length of the reporting time period (it may be a month, a quarter, or a year). The income statement shows revenues, expenses, and income. Revenues represent gross income which the company has earned during the definite period of time (usually from sales). Expenses represent the cost of providing goods and services during a given period of time. Expenses include costs incurred while conducting the operations of the firm and financial expenses, such as interest on debt and tax owed. Net income is the sum which is left after expenses are subtracted from revenues. In addition to the income statement, many companies prepare a short statement of retained earnings.

The balance sheet shows the firm’s assets, liabilities, and equity at a given point in time. On the balance sheet the firm’s assets are listed in order of their liquidity. Liquidity is the ease with which you can convert an asset to cash. The liability and equity section of the balance sheet shows how the company’s assets were financed. The funds come from those who have liability (debt) claims against the firm or from those who have equity (ownership) claims against the firm.

The statement of cash flowslike the income statement shows how cash flows into and out of the company over a definite period of time. The statement of cash flows is constructed by adjusting the income statement to distinguish between income and cash flow, and by comparing balance sheets at the beginning and at the end of the relevant period of time. The statement of cash flows shows cash flows in operating, investing, and financing activities, as well as the overall net increase or decrease in the flow of the firm.

Sources of funds

Commercial banks are financial institutions that exist primarily to lend money to businesses. Banks also may lend to individuals, governments, and other entities, but most of their profits typically come from business loans. Commercial banks make money by charging a higher interest rate on the equipment and other facilities. The banks do most of the business by receiving funds from depositors and lending the funds to those who need. The main financial goal of the banks is to maximize value to the stockholders. It is necessary for any bank to get the “charter” before it can act. Commercial bank charters are issued by federal government or the government of the state where the bank is located. Commercial banks are managed just like other companies. They have stockholders, employees, managers.

Finance companies are nonbank firms that make short-term and medium-term loans to consumers and businesses. They often serve those customers who don't qualify for loans at other financial institutions. Like banks, finance companies operate by taking in money and lend­ing it out to their customers at a higher interest rate. A major difference between fi­nance companies and other financial institutions, however, lies in the source of finance company funds. Banks receive most of their funds from individu­als and businesses that deposit money in accounts at the institutions. Finance com­panies generally get their funds by borrowing from banks, or by selling commercial paper.

There are three main types of finance companies: consumer, commercial, and sales. Here are the characteristics and functions of each type.

Consumer Finance Companiessometimes known as small-loan companies, make small loans to consumers for car purchases, recre­ational vehicles, medical expenses, vacations, and the like. Consumer finance compa­nies often make loans to customers with less than perfect credit. Because the customers are a higher risk, the interest rates charged on loans are usually a little higher to compensate for the greater risk.

Commercial Finance Companiesconcentrate on providing credit to other business firms. A special type of commercial finance company is called a factor. Factoring is the buying of a business firm's accounts receivable, thus supplying needed funds to the selling firm. Commercial finance companies also make loans to businesses, usually with accounts receivable or inventory pledged as collateral.

Sales Finance Companies.The mission of sales finance companies is to help the sales of some corporation (indeed, many are subsidiaries of the corporation whose sales they are promoting). In the automotive industry, for example, customers are more likely to buy cars from dealers that offer financing on the spot than from deal­ers who have no financing programs.

Date: 2015-12-24; view: 890