XYZ Construction

The Chief Financial Officer at XYZ Construction Inc. has been promoted to Vice President of Overseas Operations. This void leaves the company with a lack of understanding in regard to several key financial and accounting metrics. The following paper has been created as an instructional measure in an effort to fill that void with the knowledge necessary to continue operations during the transition period and to assist the company in understanding financial reports. The focus of the document will surround the management of the balance sheet, income statement, operating cash flows, statement of retained earnings, and net working capital.

The income statement is a financial document that reports revenues, expenses, and profitability. The simple math equation for the statement is revenues minus expenses equals net income (Bakar, Lamkin, & King, 2005). XYZ is a construction company; therefore, the financial statements will reflect this style of operation. Revenues will be comprised of money entering the business for construction services provided. The first set of expenses that are reduced from total sales is the cost of goods sold. This is an expense category used for all expenses directly relating to the construction services provided. In the construction industry, these expenses are inventories, wages payable, and materials used directly in the service provided. The income statement then reduces indirect expenses from gross profit to arrive at a profit before taxation. The tax rate for the business is applied and taxes are subtracted to arrive at net income. This is the best measure of true profit as no additional expenses are subtracted from this value.

The balance sheet illustrates the assets and liabilities inherent to the company. The accounting equation for the balance sheet is assets equal liabilities plus owners’ equity (Beechy & Conrad, 1998). This equation should always be true. The assets will be listed at the top of the balance sheet and will be ordered in terms of liquidity. At the top of the list will be cash and cash equivalents and at the end of the list will be long term investments, if any. The liabilities section will include items such as accounts payable, bank loans, and any stock outstanding. The last section is owners’ equity and this illustrates the book value of the company and the residual claim on the business above liabilities.

The statement of retained earnings is a financial report that shows how the profits are being managed for the company. Net income can be paid as dividends, withdrawn by owners, or retained in an account called retained earnings (Accounting Tools, 2014). This statement is provided as transparency to show how retained earnings have changed during the accounting period. There are four basic points discussed in the statement as follows: retained earnings (the end balance), beginning retained earnings (the previous month’s ending balance), net income (pulled from the income statement), and withdrawals by owners.

Operating cash flow and net working capital are very important cash-flow considerations. Operating cash flow is the reported amount of cash produced through XYZ’s construction management and planning operations. This is an important metric because it shows whether or not the company can sufficiently grow its operations. If the cash flow from operations is negative, the company must seek external financing to grow. If the cash flow is positive, growth through operational profit may be adequate. Operating cash flow is an important consideration because it removes economic expenses such as depreciation and amortization from the calculations that are present on the income statement. Net working capital is the measure of assets minus liabilities. This value is an important measure of business efficiency as well as the company’s ability to meet debt obligations. This is the amount remaining after all assets cover liabilities and is often regarded as the book valuation of the company.

References

Accounting Tools. (2014). Statement of Retained Earnings. Retrieved from http://www.accountingtools.com/statement-of-retained-earnings

Bakar, Lamkin, & King. (2005). Advanced Financial Accounting. Retrieved from http://www.ocf.berkeley.edu/~cchang/pdf%20docs/ch003.pdf

Beechy & Conrad. (1998). Intermediate Accounting. McGraw Hill. Retrieved from http://www.mcgrawhill.ca/college/beechy1/graphics/beechy1iab_student/slideshow/sld04.pdf