Accounting – 1.1 The purpose of accounting | e-Consult

Accounting information is critical for evaluating the financial viability of a business expansion. A thorough analysis requires examining various aspects of the business's financial position and projected future performance. Here are three examples of how accounting information can be used:

• Profitability Analysis (Income Statement): The income statement shows the company's profitability. Management can project the potential revenue and expenses associated with the expansion and use this information to estimate the expected profit increase. A positive projected profit increase is a strong indicator of financial viability. If the projected profit is insufficient to cover the expansion costs and provide a reasonable return on investment, the expansion may not be viable.
• Liquidity Analysis (Balance Sheet & Statement of Financial Position): Expansion often requires significant upfront investment. The balance sheet provides information about the company's assets and liabilities. Management needs to assess whether the company has sufficient liquid assets (e.g., cash, accounts receivable) to finance the expansion. A low current ratio (current assets / current liabilities) might indicate liquidity problems and raise concerns about the expansion's feasibility. The statement of financial position shows how the expansion will impact the company's assets and liabilities.
• Solvency Analysis (Balance Sheet): Expansion may involve taking on additional debt. The balance sheet shows the company's debt levels. Management needs to assess whether the company can comfortably service the additional debt. A high debt-to-equity ratio (total debt / total equity) might indicate a high level of financial risk and make the expansion less attractive. A strong solvency position is essential to ensure the company can handle the increased financial burden.
• Cash Flow Analysis (Statement of Cash Flows): The statement of cash flows shows the movement of cash in and out of the business. Management needs to project the cash flows associated with the expansion to ensure that the company has sufficient cash to fund the project and meet its obligations. A negative projected cash flow could indicate that the expansion is not financially viable.

By analyzing these and other accounting data points, management can make an informed decision about whether to proceed with the expansion. A comprehensive financial analysis, supported by robust accounting information, significantly reduces the risk of making a costly mistake.