Financial Accounting Fundamentals: Statements & Ratios

Understanding Accounting and Financial Statements

Accounting, within economics, is the study of business assets, the rules, and the scientific basis for the registration of economic information within an enterprise.

Key Components of Annual Accounts

Annual accounts, comprising the balance sheet, profit and loss account, the statement of changes in equity, and the memory, form a unified set. These accounts are financial statements that report on the company's results and its financial position. They include the following:

• The Balance Sheet

  Reports on the financial situation of the company at the close of a given fiscal year.

• The Profit and Loss Account

  Reports on the performance of the company for a year from its business operations.

• The Statement of Changes in Equity

  Informs us of changes in the composition of the company's equity from one year to another.

• The Cash Flow Statement

  Reports changes in the monetary position from one year to another.

• The Memory Document

  Provides relevant quantitative and qualitative information for decision-making not included in the previous statements.

Mandatory Nature and Standardization

The content and structure of financial statements are designed to provide information to interested parties to understand the company. These accounts are mandatory and must be prepared by the employer or administrators within a maximum period of three months after the close of the fiscal year. There are also official and common models to standardize the content for SMEs.

Specific Account Details

The Profit and Loss Account

The Profit and Loss Account is a statement that aims to calculate the result a company obtained during a financial year. It also explains the composition of the outcome and the operations that were performed to reach this result. This account is a dynamic statement.

The Memory Document

The Memory is an explanatory document that extends the content of other annual accounts. The more comprehensive the comments, the more they help recipients and users of this information to understand the situation of the company.

Understanding Financial Ratios

Definition of a Financial Ratio

A ratio is a relationship involving two economic magnitudes. In accounting, a ratio is an indicator that, through the relative comparison of two values expressed as a ratio, analyzes a specific aspect of the business situation, assessing its proximity to an optimal or critical threshold.

Key Types of Financial Ratios

Here are some common types of financial ratios:

• The Cash Ratio (Immediate Solvency)

  Also known as the immediate solvency ratio, it indicates the company's ability to liquidate its short-term debt without risk of interruption of payments.

• The Liquidity Ratio

  Compares current assets to current liabilities and shows the liquidity situation of the company's treasury, though not as immediately as the cash ratio.

• The Solvency Ratio (Total Investment Guarantee)

  Relates total debt to equity and measures the company's overall capacity to meet its debts.

Economic Profitability (Return on Assets)

Economic profitability (or return on assets) measures the performance of the company's total investments. It relates earnings before interest and taxes (EBIT) to total assets.