UNDERSTANDING FINANCIAL PERFOMANCE

Financial performance is measured using financial statements. It is important for any business (profit
making or non-profit making) to prepare asset of financial statements at regular intervals like
monthly, quarterly, half yearly and annually.

Financial statements consist of:

a) Statement of Comprehensive Income

b) Statement of Financial Position
c) Cashflow Statement

Users of Financial Statements:

Users of financial statements have different interests and below are the users:

i) Shareholders – interested in profitability, stability and solvency. (return on investment)

ii) Management – interested in the performance of the organisation in order to make
decisions to improve the performance of the business.
iii) Creditors/ Lenders – interested in the liquidity of the organisation to assess the
business’ ability to repay its debt.
iv) Labour and Unions - interested in the profitability of the organisation to ensure the
staff’s welfare and negotiation for salary increases.
v) State / Government - interested in the profitability of the organisation so that they can
levy the right income tax.
vi) Credit Bureaux – They need the statements for their credit ratings
vii) Investment Analysts – investigating a firm for making an investment decision.

Key Generally Accepted Accounting Principles

i) Accounting Entity - The entity to which the financial statements belong to should be
clearly defined. Only transactions related to that accounting entity must be recorded.
ii) Money measurement – the currency of the country should be used as a measurement
to express the assets and labilities and owners’ equity.
iii) Conservatism - Profits of an organisation should not be overstated. They must be
arrived at using the most conservative approach.
iv) Consistency concept – There must be consistency of accounting treatment of like terms
within each accounting period and from one period to another.
v) Materiality – Transactions with material in relation to the scope of an entity’s activities
effect must be all be recorded.
vi) Historical Cost – Assets are initially brought into account in accounting processes at the
cost the entity incurred in acquiring them.
vii) Double-Entry System – For every debit entry there must be a credit entry.
viii) The going - concern concept – Financial statements should be prepared in a manner
that assures the continuity of the entity.
ix) Accounting period - Costs and Income should be recognised in the same accounting
period. Revenues and cost should be accrued (i.e. recognised as they are earned or
incurred and not as money is received or paid.)
x) The realisation principle – refers to the two conditions that must be met in recognising
income.: It must have been earned and realised.

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Business Finance Notes
 xi) The accrual principle - in calculating profit for a specific period, only income earned
during that period may be brought in to account and only expenses incurred during the
same period must be included in the computation of profit or loss.

Classification of financial information.

There are five types of accounts namely

 Assets: Something a business owns or controls (e.g. cash, inventory, plant and
machinery, etc)

 Liabilities: Something a business owes to someone (e.g. creditors, bank loans, etc)

 Owner’s Equity: What the business owes to its owners. This represents the amount of
capital that remains in the business after its assets are used to pay off its outstanding
liabilities. Equity therefore represents the difference between the assets and liabilities

 Income: (Revenue) What the business has earned over a period (e.g. sales revenue,
dividend income, etc)

 Expenses: The cost incurred by the business over a period (e.g. salaries and wages,
depreciation, rental charges, etc)

Accounting Equation

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Business Finance Notes
Changes in Financial Position

Business transaction takes place

A document is prepared (invoice/ receipt)

Information is recorded in a journal

Debits and credits are posted to the ledger

Financial statements prepared

Double Entry

Financial Accounting is based on the double entry principle which simply means every business
transaction affects 2 or more accounts. E.g. A firm borrows N$10,000 from the bank.

- Cash will increase by $10,000 and we will have created a liability

Debit Cash/ Bank N$10,0000

Credit Liabilities N$10,000

Rule

Type of Account Rule

Assets 1. Increases are recorded on the debit
side
2. Decreases are recorded on the credit
side
Liabilities 1. Increases are recorded on the credit
side
2. Decreases are recorded on the debit
side

There are 2 ways of comparing performance:

1. Comparative Norms – Comparison within the industry

2. Historical comparatives – Within the organisation (last year versus current year)

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Business Finance Notes
Statement of Comprehensive Income

Income Statement, also known as the Profit and Loss Statement, reports the company's
financial performance in terms of net profit or loss over a specified period. Income
Statement is composed of the following two elements:

 Income: What the business has earned over a period (e.g. sales revenue, dividend
income, etc)

 Expense: The cost incurred by the business over a period (e.g. salaries and wages,
depreciation, rental charges, etc)

Net profit or loss is arrived by deducting expenses from income

Statement of Financial Position

Statement of Financial Position, also known as the Balance Sheet, presents the financial position of
an entity at a given date. It is comprised of the following three elements:

 Assets: Something a business owns or controls (e.g. cash, inventory, plant and machinery,
etc)

 Liabilities: Something a business owes to someone (e.g. creditors, bank loans, etc)

 Equity: What the business owes to its owners. This represents the amount of capital that
remains in the business after its assets are used to pay off its outstanding liabilities.
Equity therefore represents the difference between the assets and liabilities.

Cashflow Statement

Cash Flow Statement, presents the movement in cash and bank balances over a period. The
movement in cash flows is classified into the following segments:

 Operating Activities: Represents the cash flow from primary activities of a business.

 Investing Activities: Represents cash flow from the purchase and sale of assets other than
inventories (e.g. purchase of a factory plant)

 Financing Activities: Represents cash flow generated or spent on raising and repaying
share capital and debt together with the payments of interest and dividends

Auditor’s Report

Audited Financial Statements (AFS) are accepted means by which business firms report their
operating results and financial position.

The word audit when applied to AFS means that the statement of comprehensive income and
balance sheet are accompanied by an audit report prepared by independent accountants and are
expressing their professional opinion to the validity and reliability of the AFs.

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Business Finance Notes
Auditor’s report comprises of:

-Directors report
-Auditors report
- Financial statements
- Notes to the financial statements.

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Business Finance Notes