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Friday, March 23, 2012

Sample Assignment Financial Accounting

The usefulness of financial statements in meeting internal and external stakeholder requirements.

Financial statements are important reports. They show how a business is doing and are very useful internally for a company's stockholders and to its board of directors, its managers and some employees, including labor unions. Externally, they are important to prospective investors, to government agencies responsible for taxing and regulating, to lenders such as banks and credit rating agencies, and to investment analysts and stockbrokers.

Financial statements are used by businesses to view their gains or losses throughout the year, generally prepared by their accountant. Throughout the year businesses also have to file quarterly taxes. The financials provide the results that taxes are based on through the year and at years end.

These statements are used by management, labor, investors, creditors and government regulatory agencies, primarily. Financial statements may be drawn up for private individuals, non-profit organizations, retailers, wholesalers, manufacturers and service industries. The nature of the enterprise involved dramatically affects the kind of data available in the financial statements.


Usefulness of Each Part of Financial Statements

1) Internal user

Among other things, analysis of balance sheets can tell whether the company owes too much or is lending too much or has too much in inventory; its detailed attachments detail who is owed and who owes the company and what properties it owns, if any. Analysis of income statements can tell whether prices or volumes sold are not high enough to give sufficient profits and what the big and small costs of the business are. Analysis of cash flows can tell whether most needs are met through internally generated funds or whether some come from borrowings.

2) Importance to Managers

Managers of business, more than any of the other users, benefit most from the use of financial statements, especially those who are good at understanding and analyzing these statements. Managers are able to not only discover problems and find corrective actions needed through financial statements but they are also able to make projections of these statements that act as goals and standards for upcoming periods. They are then able to assess performances against these projections at the end of the accounting period.

3) Importance to External user

Current and potential investors and lenders always require financial statements for their lending or investment decisions. In important board and stockholder meetings, copies of these are always given out to participants. Analysts, brokers, rating agencies and money managers dig into these before making recommendations. Major customers and suppliers of businesses ask for these in order to stay informed. Corporate raiders, competitors and potential competitors attempt to get these before plunging into a business.

As example, the balance sheet provides the user with data about available resources as well as the claims to those resources. The income statement provides the user with data about the profitability of the enterprise detailing sources of revenue and the expenses which reduce profit. The statement of changes of financial position shows the sources and uses of a firm's financial resources, demonstrating trends in the alteration of its capital structure. The statement of retained earnings reconciles the owners' equity section of successive balance sheets, showing what has happened to generated revenue.

Government officials are generally concerned that reporting and valuation regulations have been complied with -- and that taxable income is fairly represented. Labor leaders pay particular attention to sources of increased wages and the strength and adequacy of pension plans (which tend to be chronically under funded). Owners, shareholders and potential investors tend to be most interested in profitability. Many investors look for a high payout ratio (cash dividend/net income). Speculators pay more attention to stock value insofar as growth companies tend to have a low payout ratio because they reinvest their earnings. Bondholders are inclined to look for indicators of long-run solvency. Short-term creditors, such as bankers, pay special attention to cash flow and short-term liquidity indicators, such as current ratio. Both classes of creditors prefer lending to firms with low (usually no higher than 40-50%) leverage ratios, such as debt to total assets.

As indicated earlier, management can use financial statements for diagnostic purposes -- with different managers paying attention to different ratios. A buyer may look closely at inventory turnover. Too much inventory may mean excessive storage space and spoilage, whereas too little inventory could mean loss of sales and customers due to stock shortages. A credit manager may be more interested in the accounts receivable turnover to assess the correctness of her credit policies. A high sales-to-fixed-assets ratio reflects efficient use of money invested in plant and in other productive or capital assets. Higher levels of management, as with investors, tend to look at overall profitability ratios as the standards by which their performance is judged (Tamari,197).

Financial statements are intended to be understandable by readers who have a reasonable knowledge of business and economic activities and accounting and who are willing to study the information diligently. Financial statements may be used by users for different purposes:

  • Owners and managers require financial statements to make important business decisions that affect its continued operations. Financial analysis is then performed on these statements to provide management with a more detailed understanding of the figures. These statements are also used as part of management's annual report to the stockholders.
  • Employees also need these reports in making collective bargaining agreements (CBA) with the management, in the case of labor unions or for individuals in discussing their compensation, promotion and rankings.
  • Prospective investors make use of financial statements to assess the viability of investing in a business. Financial analyses are often used by investors and are prepared by professionals (financial analysts), thus providing them with the basis for making investment decisions.
  • Financial institutions (banks and other lending companies) use them to decide whether to grant a company with fresh working capital or extend debt securities (such as a long-term bank loan or debentures) to finance expansion and other significant expenditures.
  • Government entities (tax authorities) need financial statements to ascertain the propriety and accuracy of taxes and other duties declared and paid by a company.
  • Vendors who extend credit to a business require financial statements to assess the creditworthiness of the business.
  • Media and the general public are also interested in financial statements for a variety of reasons

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