Role of Financial Statements for Stakeholders - Essay Example

Financial ments provide comprehensive information about the reporting entity that is useful to existing and potential stakeholders   Contents Contents 2 Introduction 3 Critical discussion in terms of capital maintenance 3 General purpose of financial statements 6 Summary and conclusion 8 References 10 Introduction The purpose of this piece of work is to analyze the importance of preparing and presenting financial statements containing comprehensive information of the companies. The general purpose of the financial statements with its key components has been reviewed in this piece of work. The regulatory standards and the importance of the true and fair representation of financial information and ethical aspect of accounting have been emphasized in this work. The paper starts with the examination of various financial parameters that satisfies the comprehensive nature of the financial information. The role of the accountants and the auditors in ensuring a true and fair view of the financial statements has been explained. This is followed by the review of the key components in the financial statements which includes the income statement, balance sheet and the cash flow statement. The parameters of the income statement, balance sheet and the cash-flow statement and the information communicated by these key components have been explained. The interpretation of the key components of the financial statements fulfils the general purpose of the companies in communicating the effectiveness of the strategies for capital maintenance and wealth maximization. Critical discussion in terms of capital maintenance The financial statements are the means of communicating to the users about the business performance of the company. The companies of all business sectors all over the world have used the financial statements as the primary instrument of informing the stakeholders whether existing or potential, about the activities of the company in the area of its business throughout the year (Baker and Powell, 2009, p.75). The users of the financial statements include the existing shareholders, the internal stakeholders that include the employees and the management, the external stakeholders which includes the customers, government, creditors and lenders, the potential investors, etc. All the users of the financial statements, whether internal or external, are only interested in maximization of profits of the company. The companies also carry out their business with the primary aim of maximization of wealth of the shareholders (Bhattacharyya, 2011, p.62). The various measures taken by the company during its operations in the business throughout the year are communicated to the stakeholders with the help of financial statements. Therefore, the financial statements of the companies are prepared and represented in a manner that they contain comprehensive information about the reporting entity that is useful for the existing and the potential stakeholders. The review of several cases of the companies reporting their business activities with the help of financial statement and reporting over the years reveal that the companies have started to adopt increasing focus on the true and fair representation of the financial statements aimed at communicating the strategies and ultimate results of capital maintenance. The companies have prepared and presented the financial statements with exhaustive information on their business which includes the performance of the capital employed by mainly the owners and the major stakeholders (Butler, 1993, p.95). The information on the deployments of capital of the business in several avenues like investments, credits and other ventures are also reported through the financial statements. The companies prepare the financial statements with comprehensive information on the strategies for investments, credits offered, debts undertaken, etc. The total capital available with the business and the divisions between equity and debt capital of the company are indicated in the financial statements (Crosson and Needles, 2010, p.84). The rationale behind the acquiring of the equity and debt capital backed by various investments strategies are communicated to the users of the financial statements. The companies aim to provide comprehensive information on the various risks involved in the avenues of investments in which the company has engaged (Dickie, 2006, p.74). The notes to the financial statements contain useful information for the users on the various risk like the interest rate risk, foreign currency risk, credit default risk, liquidity risk, market risk factors and others that have influenced the decision of deployment of capital of the company. The comprehensive information presented through the financial statements also includes determination of cost of capital of the companies (Gibson, 2010, p.57). The cost of capital is determined by the companies as the weighted average of the cost of equity and the cost of debt capital. The ultimate area of interest for the users in the financial statements after taking into consideration the cost of capital and the associated risk factors is the return achieved by the business on the capital employed. This is the percentage of earnings before interest and tax that the companies have been able to earn on the average debt liabilities and the equity capital incurred by the company (Jackson, Sawyers and Jenkins, 2008, p.47). The comprehensive information on the return on capital provides the effectiveness on the capital maintenance through the means of financial statements and reports. There are several examples of companies in the past, namely the Lehmann Brothers, WorldCom, Satyam Computers, etc. who have undertaken mal-practices in the preparation of the financial statements. This has misguided the existing and the potential stakeholders on the effectiveness of capital maintenance of the companies (Khan, 2004, p.65). This has led to investments in the stocks of the companies which has resulted in the erosion of wealth and also produced diminished returns on the capital. Thus the interest of the stakeholders was affected due to fraudulent financial statement presented by these companies which also led them ultimately to bankruptcy (Lemieux, 2013, p.52). These companies produced inflated financial statements which either contained misappropriated profits or lower than actual level of debt incurred by the company. In context of declining reliability of financial statements that exposed the investors to bad investments, IASB and FASB has set up new standards to tighten the measures for ensuring true and fair view of financial statements (Megginson and Smart, 2008, p.91). The accountants and the auditors are required to follow the accounting codes and apply accounting ethics while preparing and validating the financial statements. The regulatory standards in the financial markets all over the world have ensured that the financial statements are prepared and presented by the companies in a comprehensive manner to ensure protection of the existing shareholders and the potential investors. General purpose of financial statements The general purpose of the financial statements is to present the existing stakeholders and the potential investors with comprehensive information on the capital maintenance and the effectiveness of the business performance. This could be explained in detail with the review of the key components of the financial statements. The aspect of capital maintenance and the effectiveness of the capital deployed by the company in producing returns to the shareholders could be understood from the income statement, balance sheet and cash-flow statement of the company which has reported the relevant figures through the financial statements (Periasamy, 2009, p.16). The income statement communicates the users on the sales and revenue earnings of the companies, the cost of sales, gross profits, operating cost and profits, the interest and the taxes paid and the net profit for the year (Warren, Reeve and Duchac, 2008, p.48). The users of the financial statements would be able to use this figures for the purpose of analysis and taking informed decisions on investment in the company stocks. The existing shareholders could view the true and fair position on the profit margins. The gross profit margin could be obtained from the income statements as a percentage of the gross profits earned by the company over the total sales and revenue earnings (Nekrassov, 2008, p.43). The figures in the income statement could also be compared with the figures of the previous year on the company’s performance which provides the stakeholders with the comparative rise or decline in the business performance of the company (Warren, 2010, p.24). This information is communicated by the companies to the users of the financial statements with the purpose of spreading information on the profitability and the capital maintenance of the companies in attempt for maximization of wealth (Northcott, 1992, p.38). This information is used by the shareholders by the existing shareholders in order to decide on whether to hold their stock positions or leave the stockholding position. The potential investors use this information to take informed decision on the purchase of the new stocks of the company. The creditors and the lenders use this information in order to decide the project feasibility at the time of offering credits to the company. Apart from the capital maintenance of the company, the income statement also communicates the users on the aspect of cost control and economies of scale achieved by the company over the years (Pandey, 2006, p.87). The amount of profits earned by the company and the earnings per share of the company is also communicated to the users of the financial statements. The total earnings of the company are used by the stakeholders to find the price to earnings ratio. This ratio is useful for the business to communicate the acceptance level of the stocks among the investors in the capital markets (Pratt1, 2003, p.73). The general purpose of the companies is also fulfilled through the other components of the financial statements which are namely, the balance sheet and the cash flow statement. The balance sheet provides a break-up of the total assets into components like current assets and the current liabilities (Pratt2, 2003, p.32). The amount of current assets and the current liabilities could be compared by the existing and the potential stakeholders to determine the ability of the companies to service the short term liabilities with the help of its current assets. The balance sheet is used to communicate the equity holdings of the company to the stakeholders. The return on the capital employed by the company is the amount of earnings generated from the investment of equity capital of the company (Rao, 2000, p.74). The information presented through the key components of the financial statements is used to communicate the effectiveness of the capital maintenance of the companies. The cash flow statement is another key component of the financial statements that is used to represent the information on the volume of cash flows generated by the activities of operation, investment and financing that have been strategically adopted for the purpose of capital maintenance (Sofat and Hiro, 2008, p.83). The users of the financial statements are, therefore, are communicated through the financial statements about the contribution of the strategic activities of the company like, operations, financing and investments in the generation of profits. The key components of the financial statements, therefore, fulfil the general purpose of communicating the stakeholders of the company on the measures and the results achieved in the context of capital maintenance and wealth maximization (Tarantino, 2010, p.62). Summary and conclusion The aspect of comprehensive information presented and reported through the financial statements by the companies is useful for communicating the existing and potential stakeholders on the aspect of capital maintenance and the maximization of wealth of the shareholders. The considerations of the cost of capital incurred by the company and the associated risks in the acquiring of debt and equity capital are generally communicated with the help of financial statements. Several examples of companies reporting fraudulent financial statement in order to misguide the investors have led to tightening of regulatory frameworks. This has ensured ethical accounting practices that have been able to depict true and fair view of financial and business performance of the company to its external and internal stakeholders. These measures aimed at protection of the investors and the stakeholders have enabled the companies to fulfil the general purpose of communicating the strategic success in maintaining the capital fund over the years and maximize profits to the best interest of its stakeholders. The key components of the financial statements have provided useful information on the profitability, profit margin, return on equity and the liquidity of the company in the short term and long term. References Baker, H. K. and Powell, G. 2009. Understanding Financial Management: A Practical Guide. NJ: John Wiley & Sons. Bhattacharyya, D. 2011. Management Accounting. New Delhi: Pearson Education India. Butler, R. 1993. Strategic Investment Decisions: Theory, Practice, and Process. New York: Taylor & Francis. Crosson, S. V. and Needles, B. E. 2010. Managerial Accounting. Stamford: Cengage Learning. Dickie, R. B. 2006. Financial Statement Analysis And Business Valuation for the Practical Lawyer. Washington: American Bar Association. Gibson, C. H. 2010. Financial Reporting and Analysis: Using Financial Accounting Information. Stamford: Cengage Learning. Jackson, S. R., Sawyers, R. B. and Jenkins, J. G. 2008. Managerial Accounting: A Focus on Ethical Decision Making. Stamford: Cengage Learning. Khan, M. Y. 2004. Financial Management: Text, Problems and Cases,4e. Delhi: Tata McGraw-Hill Education. Lemieux, V. 2013. Financial Analysis and Risk Management: Data Governance, Analytics and Life Cycle Management. Berlin: Springer. Megginson, W. L. and Smart, S. B. 2008. Introduction to Corporate Finance. Stamford: Cengage Learning. Nekrassov, A. 2008. Cost of Equity and Risk in Earnings Components. New York: ProQuest. Northcott, D. 1992. Capital Invest Decision Making. Stamford: Cengage Learning. Pandey, I. 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