1.

0 Financial Statements

Financial accountancy (or financial accounting) is the field of accountancy concerned with the
preparation of financial statements for decision makers, such as stockholders, suppliers, banks,
employees, government agencies, owners, and other stakeholders. The fundamental need for
financial accounting is to reduce principal-agent problem by measuring and monitoring agents'
performance and reporting the results to interested users.

Financial accountancy is used to prepare accounting information for people outside the
organization or not involved in the day to day running of the company.

Management accounting provides accounting information to help managers make decisions to

In short, Financial Accounting is the process of summarizing financial data taken from an
organization's accounting records and publishing in the form of annual (or more frequent) reports
for the benefit of people outside the organization.

Financial accountancy is governed by both local and international accounting standards.

Financial Statements
a) Profit and loss Statement or income statement

This indicates whether the business will bring in profit or loss in a given year. A profit and loss
statements indicates all revenues and all costs incurred in a given period of time.

b) Cash Flow Statement

Cash in business can be compared to water that flows in a river. Cash flows in from sales, loans
and equity. But in a process of offering services or producing goods, cash flows out to pay for
materials, salaries, rent, utilities, etc. Businesses which have more cash out flows than inflows
get into financial problems.

c) Balance Sheet

A balance sheet takes a snapshot within a specified time of what a business owns and what it
owes. It has two sides: One side records its properties i.e. anything it can claim its own and of
value e.g. cash accounts receivables, debtors, machines,, etc. These are the assets. The other side
shows where the money to finance the purchases of properties came from e.g. from equity, loan
or share holder funding. This side is called liabilities and owner equity.

Financial statements ; Examples

Njombe Natural Resource Company Ltd has managed to get a bank loan from CRDB Bank to construct a
hydro power plant that can generate electricity from water falls in Ruhunji River in remote Njombe. The
electricity will be sold to TANESCO National grid which passes nearby the plant. The Company has
prepared a business plant for the plant and the financial statements are shown in table 6.1 through 6.3.
Undertake profitability and solvency analysis for year 1 and 5 using data from the Tables. Comment on
the financial performance of the plant.
TABLE 6.1: INCOME STATEMENT IN “000” OF TSHS OF MAPEMBASI HYDRO POWER PLANT

1 2 3 4 5

A. TOTAL SALES 4,050,505 4,514,265 4,739,978 4,976,977 5,225,826

LESS:

B. DIRECT COTS

Community levies 1,000 1,100 1,210 1,331 1,464

Direct labour 2,650 2,915 3,207 3,527 3,880

Utilities 1,200 1,320 1,452 1,597 1,757

Sub total 4,850 5,335 5,869 6,455 7,101

INDIRECT COSTS

C. Other indirect costs 93,162 103,828 109,019 114,470 120,194

Depreciation of equipments 703,000 703,000 703,000 703,000 703,000

Maintenance costs 303,788 338,570 355,498 373,273 391,937

Sub total 1,006,788 1,041,570 1,058,498 1,076,273 1,094,937

D TOTAL COSTS (B +C) 1,011,638 1,046,905 1,064,367 1,082,729 1,102,038

E OPERATING PROFIT(A-D) 3,038,867 3,467,360 3,675,611 3,894,249 4,123,788

Less

F INTEREST PAYMENTS 0 0 3,158,379 3,000,460 2,842,541

G NET PROFIT 3,038,867 3,467,360 517,232 893,788 1,281,247

Less

H TAXES 911,660 1,040,208 155,170 268,137 384,374

I NET PROFIT AFTER TAX 2,127,207 2,427,152 362,063 625,652 896,873

J. CUMULATIVE PROFIT 2,127,207 4,554,359 4,916,422 5,542,074 6,438,947

TABLE 6.2: CASH FLOW STATEMENT IN “000” OF MAPEMBASI HYDRO POWER PLANT
 ITEM YEAR

0 1 2 3 4 5

A. INFLOWS:

Equity 7,946,300

Term Loan 18,578,700

Cash carried forward 0 0 2,127,207 4,554,359 3,684,204 3,684,204

Net Profit After Tax 0 2,127,207 2,427,152 362,063 625,652 625,652

TOTAL INFLOWS 26,525,000 2,127,207 4,554,359 4,916,422 4,309,856 4,309,856

B. OUTFLOWS:

Capital Expenditure 26,525,000

Working Capital Increase

Loan payment 0 0 928,935 928,935 928,935

TOTAL OUTFLOWS 26,525,000 0 0 928,935 928,935 928,935

NET CASH 0 2,127,207 4,554,359 3,987,487 3,380,921 3,380,921

TABLE 6.3 BALANCE SHEET OF MAPEMBASI HYDRO POWER PLANT IN ‘000’ OF TSHS
 YEAR
ITEM
1 2 3 4 5

FIXED ASSETS:

Opening Balance 22,385,272 21,682,272 20,979,272 20,276,272. 19,573,272.

Less: Depreciation 703,000 703,000 703,000 703,000 703,000

Net Fixed Assets 21,682,272 20,979,272 20,276,272 19,573,272. 18,870,272.

CURRENT ASSETS:

Cash in Bank 6,969,934 9,171,152 9,307,279 9,706,996 10,377,934

Net Current Assets 6,969,934 9,171,152 9,307,279 9,706,996 10,377,934

TOTAL ASSETS 28,652,206. 30,150,424. 29,583,551. 29,280,268. 29,248,206.

LIABILITIES:

OWNERS EQUITY 7,946,300 7,946,300 7,946,300 7,946,300 7,946,300

TERM LOAN 18,578,700 17,649,765 16,720,830 15,791,895 14,862,960

ACCUMULATED NET PROFIT 2,127,207 4,554,359 4,916,422 5,542,074 6,438,947

TOTAL ASSETS 28,652,206. 30,150,424. 29,583,551. 29,280,268. 29,248,206.

Analysis of Company Performance

There are three groups of formulae that are used to appraise especially company
performance. They include formulae for profitability analysis, measure of solvency
and efficiency ratios.
 A. Profitability analysis

Measures used under this category include net profit ratio, asset turnover ratio and
return on investment.

Net profit ratio should at least be 0.15.

Assert Turn Over ratio should at least be 1.

Return on investment should at least be 0.15

Profitability Index should at least be 1.

B. Measures of Solvency
There are three measures of solvency namely the current ratio, the gearing ratio
and the acid test ratio or sometimes called the quick ratio.

The current ratio should be around 2.

Acid test ratio should at least be 1.1

The gearing ratio should be less or equal to 30%.

There are two measures of efficiency namely the inventory turnover ratio and the
average collection period.

The inventory turnover ratio should be greater than or equal to 2.

The average collection period should be between 3 and 6 months.