Corporate Governance and Financial Statements - Coursework Example

Contents Contents Introduction 2 Corporate Governance & Financial ments 2 Annual Reports and their Impact 3 Financial Ratios 3 Inventory turnover 4 Receivable Turnover 4 Asset Turnover 4 Liquidity Ratios 5 Profitability Ratios 5 Variance Analysis 6 Control and Planning 7 Conclusion 7 References 8 Introduction It is important for every organization whether smaller or large to keep track of its performance and maintain a track record of healthy performance. Given the fact that businesses have now become more volatile, it is important that a proper understanding of the various performance variables as well as parameters is gained in order to make correct and timely decisions. However, to properly assess the performance, it is critical that a more comprehensive or rather macro view of the overall environment must also be considered in order to assess the performance of a firm in its right context.(Palepu, Healy & Bernard, 2000). There are various performance measurements including those that are identified through financial ratios as well as those which are generated with the help of management accounts. Whatever the source the nature and use of the information generated with the help of both these sources provide a critical insight into the overall historical performance of a firm. The assessment of budgetary and cost management accounting will provide an insight as to how the firm is meeting its internal targets whereas financial ratios may provide a broader picture of the overall performance of the firm.(Fabozzi & Peterson, 2003). This paper will provide a comprehensive overview of the various performance measures that need to be considered in order to perform performance analysis of a firm. Corporate Governance & Financial Statements Reporting of Corporate Governance issues has recently attracted a lot of attraction and firms besides communicating with their stakeholders in other forms also use financial statements as a tool to communicate their performance against corporate governance goals. Studies have indicated that the decisions of the investors also depend upon how the firm implements its corporate governance. (Chalevas & Tzovas, 2010). Thus it is important that financial statements must provide a clear and concise description of the firm’s performance in terms of its corporate governance efforts. Annual Reports and their Impact Annual reports provide important information to the shareholders as such the influence of annual reports on stock market is significant. Since the annual report provides detailed information on the financial performance of a firm for the year, investors therefore make their decisions based on the information contained in the financial statements. Further, information provided in the financial statements can also help to detect fraudulent financial reporting made by the firms.( Kaminski, Wetzel & Guan, 2004) Financial Ratios Financial ratios provide a critical assessment of the overall performance of a firm over the period of time. It is however, critical to note that financial ratios can either be analyzed through performing trend analysis or by making a comparison between the firm and the industry. Trend analysis is performed when the performance is compared over the period of time in order to indicate as to whether certain performance measures have improved over the period of time or not. A comparison with respect to time therefore provides a critical insight into whether the firm has performed better or not over the period of time. Industry comparison on the other hand allows making a comparison as to whether the firm has performed better or not with respect to the industry.(Kaminski, Wetzel & Guan 2004). This type of analysis however, may not be suitable for a firm like us which is relatively small. Following section will discuss some of the critical performance measures in terms of financial ratios: Inventory turnover Holding up excessive inventory costs the firms and it is important that a firm must control its inventories in a manner that provides it a competitive advantage not only in terms of controlling its costs but also ensure that the firm’s products are readily saleable.(Bento & White, 2006). Monitoring of inventory turnover is therefore critical in terms of assessing the efforts of the sales staff is selling the firm’s products as well as the marketability of the products in the target markets of the firm. A higher inventory turnover therefore indicates higher efficiency of the management in managing its inventory. Receivable Turnover Monitoring receivable turnover of the firm is another important performance measure which can effectively indicate the management of the receivables of a firm. A higher receivable turnover may indicate that the firm’s products are selling very fast and receivables are collected at relatively higher pace. A high receivable turnover therefore indicates that the firm manages its cash flows in more appropriate manner. Further, a good receivable management coupled with good inventory management practices will readily provide a good measure of performance of the management in terms of their ability to manage working capital of the firm.(Wiseman,2009). Asset Turnover Asset turnover is also one of the most critical performance measures as it indicates the efficiency with which all the assets of a firm are managed by the firm’s management. A higher asset turnover will reflect that the firm’s assets are utilized in most optimum manner and resources are not wasted. A lower turnover therefore may indicate that the management is unable to deploy the assets in most profitable manner. A good manager therefore must always look at the possibility of generating higher returns from the assets by using too few of the assets in order to utilize the firm’s assets in most profitable manner.(Greer & Kolbe, 2003) Liquidity Ratios Liquidity ratios are another important indicator of the performance of a firm as it outlines whether the management has the resources to pay off its most current liabilities. Liquidity ratios are good approximation for performance because it indicates whether the firm and its management have the ability to pay off their current debts. Low level of liquidity ratios therefore may indicate that firm may not be able to generate enough cash flows to pay off its current debts. Such shortage of liquidity therefore can trigger insolvency issues for the firm and as such it is critical that liquidity ratios are managed properly.(Richard, 2007). There are two basic types of liquidity ratios which need to be considered for performance analysis i.e. current ratio as well as quick ratio. Quick ratio is considered as the more conservative approach to assess the liquidity position of the firm whereas current ratio of 1:1 is considered as more ideal situation for a firm in terms of its overall liquidity position. Profitability Ratios Probably the most important measure of performance is the assessment of the performance of firm. Since the ultimate motive of any firm is to earn profit, it is therefore important that the firm must be able to earn sustainable level of profits over the period of time. It is also important to note profitability ratios also include ratios such are return on equity because they also directly indicate as to how much return a firm is able to provide to its shareholders.(Ruth & Ward,2002). Gross profit margin and net profit margin are two important indicators of the performance of the firm in terms of its profitability. Higher margin ratios therefore can indicate two important sources of information viz a viz ability of the firm’s products to be sold on higher profits as well as the low cost of the production. It is also important to note that profit margins are also industry dependent and various industries and firms face relatively different levels of profitability over the period of time. Another important indicator of the performance of a firm in terms of return to shareholders is the return on equity. This figure may probably be considered as the most important for the owners of a private firm. A higher return on earnings would imply that the owners are getting enough returns to continue to keep their investments into the firm. Variance Analysis Variance analysis is another important tool that is very help as it uses internal cost management data to analyze important factors. Variance analysis however, is mostly used in assessing as to whether the expenses remained within the allocated budgets or not. A proper variance analysis therefore can provide important insight into the manner in which firm’s production process is managed besides indicating the over all control over the cost management. Variance analysis can also be extended to areas such as sales and profitability variance analysis in order to assess the performance of the sales team. A proper sales variance analysis will allow the management to check the effectiveness and efficacy of the sales team of the firm besides getting an insight into potential factors that may be blocking the increase in the sales of the firm.(Drury, 2006). It is also critical to note that management must take action after evaluating the variances in different heads. If variances are negative, it becomes more critical that the firm must take appropriate actions to find the gaps in performance and take remedial measures. Higher and consistent adverse variances therefore may point towards deeper problems which need to be addressed by the top management of the firm. Control and Planning The above discussion clearly reflects upon the need for having an effective system in place which requires effective control and budgeting process to be in place. This also requires that information depicted by financial ratios and variance analysis must be taken into consideration and senior management of the firm must formulated a comprehensive system that can put strong check on various overheads.(Smiths,2005). Conclusion Financial ratios as well as other managerial accounting techniques can provide comprehensive tools for assessing the performance of a firm. Financial ratios include using profitability analysis, activity ratios as well as the liquidity ratios. Activity ratios are particularly more important because they provide a critical insight into the way management is actually managing various assets of the firm besides looking into the profitability of the firm. References 1. Bento, A , White, L (2006). Budgeting, Performance Evaluation, and Compensation: A Performance Management Model. Advances in Management Accounting. 15, pp.51-79. 2. Bull, R (2007). Financial Ratios : How to Use Financial Ratios to Maximise Value and Success for Your Business. 1st. ed. London: CIMA Publishing. 3. Chalevas, C ,Tzovas, C (2010). The effect of the mandatory adoption of corporate governance mechanisms on earnings manipulation, management effectiveness and firm financing. Managerial Finance. 36 (3), pp.257-277. 4. Drury, C (2006). Cost and management accounting: an introduction. 6th. ed. New York: Cengage Learning EMEA. 5. Fabozzi, F , Peterson, P (2003). Financial Management and Analysis. 1. ed. New York: John Wiley 6. Greer, G, Kolbe, P (2003). Investment analysis for real estate decisions. 5th. ed. New York: Dearborn Real Estate. 7. Kaminski, K, Wetzel, S Guan, L (2004) Can financial ratios detect fraudulent financial reporting?, Managerial Auditing Journal, 19(1), pp.15 - 28 8. Kaminski, K, Wetzel, S Guan, L (2004). Can financial ratios detect fraudulent financial reporting? Managerial Auditing Journal. 19 (1), pp.15-28. 9. Palepu, Healy, Bernard (2000). Business Analysis . 2nd. ed. New York: South- Western College Publishing. 10. Ruth, B, Ward, K (2002). Corporate Financial Strategy. 1st. ed. New York: Butterworth-Heinemann. 11. Smith, (2005) Cost budgeting in conservation management plans for heritage buildings, Structural Survey, 23( 2), pp.101 – 110 12. Wiseman, R (2009). On the use and misuse of ratios in strategic management research. Research Methodology in Strategy and Management,. 5, pp.75-110. Read More