Financial Forecasting, Analysis and Modelling: A Framework for Long-Term Forecasting

CHAPTER 2

A Short Primer in the Accounting of Financial Statements

Chapter 2 explains the basics of the financial statements and the Generally Accepted Accounting Principles (GAAP) that underlie their construction. Financial statements are the primary source of information for most investors and analysts. While an understanding of every detail and International Accounting Standards Board (IASB)¹ rule is not necessary, it is important that the reader understands at least the basics. The accounting equation is used to prepare the balance sheet, the income statement, and the statement of cash flows and the interrelationships among these statements are explained. A sample company's financial statements highlight the abovementioned articulation by using a proper graphical exhibit. Finally the most important financial ratios are described as a means of financial statement analysis and interpretation.

2.1 THE ACCOUNTING EQUATION

Any aspiring financial modeller should be familiar with the basic accounting principles and how they are reflected in the so-called financial statements. Financial statements are standardized forms developed by accountants and financial managers in order to record business transactions. They follow the fundamental principle of accounting: matching costs and expenses with the revenues they have created. In order for costs and expenses to be matched with revenues, accountants devised what is known as the double entry system of accounting. In other words, every ...