Businesses have existed for many years and it is as old as mankind. The early forms of business involved batter trade where people used to exchange good with goods. Though they didn't use the money concept, they knew how to attach certain values to the goods they had. As time moved on and money was invented, business field changed drastically and all over the world, money is used as the medium for transaction. This necessitated the use of accounts in order to determine how an organization fairs in its operation and helps to determine whether it operates at a profit or loss.
Accounting can thus be used to forecast the performance of an organization in future The financial statements of an organization are very important to its various stakeholders. The main financial statements required for all companies by the International Accounting Standards (IAS) are the statement of financial position, the income statement, cash flow statement and other notes to the accounts which may be useful to the end user. The different stakeholders like potential investors, shareholders, government, public and employees need financial statements for different reasons according to their objectives. For financial statements to be useful to an end user, they must be analyzed and interpreted.
For financial statements to be completely objective and reflect a true and fair view, they must be prepared using the generally accepted accounting principles. These principles include consistency, going concern, accrual concept, and prudence, substance over form and materiality concept, monetary unit concern, time period assumption, Conservatism, going concern, duality aspect, objectivity, realization, matching principle and economic assumption.
According to the concept of consistency, the accounting policies should be consistent from one period to another and should not be unnecessarily changed. This enhances reliability of the financial statements and ensures that they are not manipulated. The going concern concept emphasizes that an enterprise should be viewed as if its operations were continuing for the foreseeable future. The enterprise does not intend to go into liquidation or curtail its operations significantly, thus the business entity should never be assumed to go under liquidation. Prudence, also referred to as conservatism, guides the making of financial statements. The financial statements should neither overstate nor understate facts about an organization. Economic entity assumption distinguishes the business from the propriety. For accounting purposes, any business entity should be treated differently from its owner and should not be viewed as one entity.
Monetary unit assumption on the other hand accords consideration on anything that has monetary value. In accounts, it therefore means anything that does not have monetary value can not be recognized in accounts. The monetary value forms the basic in accounts since it deals only with substances that can be tagged with monetary value in it. Time period assumption places emphasis that accounting complex activities can be determined within a short term. The activities of an organization can be determined and at times it depends on frequency at which the accounting activities are done. Some organization may do it at the end of every month whereas others do it at the end of the year to determine profit or loss that might have been experienced during that period. Objectivity principle on the other hand requires accountants to be non-biased when reporting the activities for the organization. Such reporting is based on facts and not speculation. For example all expenses and income should be accompanied by a source document like receipts, invoice among others.
Accountants are guided by this principle to be very cautious when dealing with inherent risks or uncertain events like pending litigations which may affect the financial statements. The concept of substance over form basically states that accountants should emphasize the economic form rather than the legal form when preparing financial statements. For example a company may be in possession of a leased property that generates them revenue. The asset should be included in the balance sheet even though it does not belong to the company legally. According to the materiality concept, the financial statements should disclose all items that are material enough to affect the evaluations or decisions of stakeholders. When these accounting principles and concepts are used in accordance with the rules and regulations of International Financial Reporting Standards (IFRS), the financial statements produced are objective and give a true and fair view of the organization.
The financial statements must however be analyzed by the different users to show the performance of the organization. Analysis of financial statements is done using financial ratios. The ratios are used to show the liquidity, profitability, gearing, turnover and investment viability in the organization. Liquidity ratios are mainly used to show the ability of the firm to meet its financial obligations when they fall due. These ratios show the solvency of the firm and are mainly used by trade creditors. Profitability ratios indicate how profitable the firm is and they are mainly used by potential investors, current shareholders, long-term lenders, government, competitors, among other stakeholders. Gearing ratios show the mix of debt and equity finance in the capital structure of the company.
These ratios are mainly used by lenders of the company, directors and management. The turnover/efficiency ratios indicate how well the assets of the company are being managed and utilized to achieve the profit-making objective of the firm. The ratios are mainly used by the directors, shareholders and competitors of a firm. Investment ratios show the performance of the firm in terms of how well it pays back the investment made by the shareholders. In order to show how the ratios and accounting concepts are used in measuring the financial performance of an organization, the financial statements of Starwood Hotels and resorts worldwide Inc. for the year 2010 will be used.