Financial Statements Should Be Properly Composed and Interpreted - Term Paper Example

 Financial Reporting/Statements Financial statements are used to record financial activities of an organization, they usually represent the performance of a company over a particular period of time and these analysis are used by many potential users for their respective purposes. An organization’s financial statements are used by many different users, e.g. potential investors investigate and appraise a company’s performance and based on these evaluations made with respect to the financial statements, investors decide the company which suits them. Suppliers and Customers are also among all the different users of financial statements. They use the financial statements with their own personal interests and then weigh the company’s performance accordingly. CUSTOMERS It is difficult for a company to attract a new customer than to retain one. Many organizations tend to have policies that are at the convenience of customers. Usually organizations offer their large customers with certain credit facilities to attract more customers on terms which may seem feasible to the customers. Many discounts are offered to customers on bulk purchasing but all these issues put a question mark on the liquidity of an organization, i.e. the availability of liquid funds to pay off any debts as the fall due. To tackle these situation companies offer further cash discount on prompt payments or payment made quickly. New customers are often not given any credit as they their credit worthiness is not known, companies when giving out credit to customers (often new customers) get an analysis of those customers from organizations that keep a credit worthiness record of many people or organization; these companies are usually credit rating companies. After assessing all this, organizations decide the level of credit to be given to a particular customer and for how much time. Many customers are given prompt credit as their past record with the company is incredibly good. Many different techniques are used by companies to evaluate the decision of giving their goods or services on credit, Ratio Analysis is one such technique which is used via the use of the financial statement, figures are calculated and compared with prior years or Industry trends to evaluate whether the credit given out is appropriate or higher with respect to the Industry as a whole or when compared with previous periods. Giving out credit affects the liquidity of a company. Efficiency ratios, such as the Debtors’ payment period are calculated, this ratio gives a rough measure of the average length of time it takes for a company’s debtors to pay their dues. Debtor Days/Payment Period = (Trade Debtors ÷ Credit Sales) * 365 Such ratios determine how efficient a company is operating, i.e. how quick/late a debtor pays off its debt. When giving out credit to customers, proper analysis should be done if there is a major amount involved, if customers fail to pay off their due debts, there are other ways a company can try to get their debts back, e.g Factoring, but this sometimes creates a negative view of the company in the eyes of the customer. Accordingly, giving out credit may also increase the turnover of a company, if given out on more favorable terms compared with other competitors; this in turn increases the profitability of a particular company. SUPPLIERS A supplier is usually considered a vital link for a company to achieve better financial results. Organizations tend to seek suppliers which can supply high quality material/service at a low price. Supply of suitable, cost effective and adequate material, services and labour is vital to an organization. A company tries to find a best possible supplier, which is suitable with its working environment. The interaction with suppliers can be monitored at two levels; a) Operational Level: this will focus on the supplier’s conduct under the terms of the contract. b) Attitudinal Level: this examines the degree of collaboration and trust that has been built up between the firm and its suppliers. Companies must be able to supply their customer quickly. This has led to Just in Time Systems. Deliveries must be reliable. There must be transparency in the supply chain such that upstream firms can see the order coming from customers well in advance. This is one way where a company can have a competitive edge over others, i.e. customers and supplier working together. Systems can be introduced within a company which can help with the collaboration of suppliers and customers, e.g. a customer can order on a website of a company, that order should be connected to the supplier’s system, hence a supplier can provide the appropriate raw materials to the company as soon as an order is received from the customer. This can help in reducing Holding/Warehousing costs for the company hence increasing its efficiency. A company should keep a good relation with their suppliers. Company can avail credit facilities and these credit facilities can be increased if a good record of payment is kept with the suppliers. This can help the company to polish its liquidity position, hence having enough other funds to invest in other profitable ventures. Efficiency ratios are calculated accordingly to evaluate the company’s performance. Creditor payment period helps to assess the days taken to pay a particular creditor, an increase in creditor days is often a sign of lack of long term finance or poor management of current assets resulting in the use of extended credit from suppliers, increased overdraft, etc. All this would also deteriorate the relationship with the supplier, hence tempting the supplier to ask for payment as it falls due, this in return would increase pressure on the company and hence the company would either have to take out a loan or would have to force their customers to pay out quickly, denting the reputation and the goodwill of the company in result. Suppliers when giving out credit to a company analyze their financial statement on the basis of liquidity, gearing, profitability and stock turnover. Liquidity is analyzed to ensure that the company would be having proper funds to pay off the supplier’s debt as it falls due, high gearing would be alarming as the company would be required to pay up its loan obligations first before it can pay off its other debts, suppliers in this situation might not be willing to give out credit to a company. Profitability is another factor which if low, would de-motivate a supplier to give out material or services on credit. Finally Stock Turnover periods indicate the average number of days that items of stock are held for. A lengthening stock turnover period indicates; A slowdown in trading or; A build-up in stock levels, suggesting the investments in stocks is becoming excessive or the stock has become obsolete. If the stock days and the debtor days are added together, it gives an indication of how soon stock is convertible into cash, thereby giving a further indication of the company’s liquidity. Stock Turnover = Cost of Sales ÷ Average Stock Stock Turnover (period/days) = Average Stock ÷ Cost of Sales * 365 Gearing Ratio = Long Term debt ÷ Shareholder funds * 100 Profitability Ratio (ROCE) = Sales ÷ Capital Employed * 100 Liquidity Ratio = Current Assets ÷ Current Liabilities NOTE: Figures in the financial statements i.e. Statement of Comprehensive OR Balance Sheet, are used to calculate above ratios. PROBLEMS Problems involved with the use of financial statements as a measure of deciding upon the financial performance are; The financial statements accessed might not be of the appropriate period involved The financial statements involved might not be giving a true and fair view of the financial performance i.e. they might not have been prepared in accordance with the appropriate Accounting and Legal Standards. Financial statements are useless unless they are properly interpreted. Meaningful information is usually availed via proper ratio Analysis and those ratios are compared with prior years or similar business, problem arises when it is difficult to ascertain the appropriate industry standard or if no other similar business exists. Bibliography Association of Chartered Certified Accountants (Great Britain). Financial Reporting. ACCA complete text, paper F7 (INT). Workingham, Berkshire: Kaplan Pub, 2007. Comiskey, Eugene E., and Charles W. Mulford. Guide to Financial Reporting and Analysis. New York: Wiley, 2000. Top of Form Bottom of Form Top of Form Gowthorpe, Catherine. Financial Analysis. CIMA's official learning system. Oxford: CIMA, 2008. Bottom of Form Top of Form Bottom of Form Top of Form Revsine, Lawrence. Financial Reporting and Analysis. Boston: McGraw-Hill Irwin, 2009. Rodgers, Paul. Financial Analysis. CIMA exam practice kit. Oxford: Elsevier, 2007. Bottom of Form Top of Form Bottom of Form Read More