The Types of Information and its Value in Accounting for Managers - Coursework Example

MBA- Accounting for Managers Compare and contrast the types of information, and its value to users, currently provided by the published profit and loss accounts and cash flow statements of UK companies 1. Introduction The development of corporate activities worldwide has led to the need for establishment of appropriate accounting principles that will ensure the effective control of the firms’ financial status throughout its operation – either locally or internationally. In this context, a series of financial statements has been introduced for firms around the world; the content of these financial statements is the same for all countries in the international market – only limited alterations could be possibly exist in accordance with the accounting standards set by the national legislation. In Britain, accounting was gradually developed under the needs of the government to have a clear view on the activities of the firms operating across the country. The country’s Courts have also participated actively in the development of accounting principles through the interpretation and application of the relevant law in any dispute that was brought before them. In many cases, the identification by judges of the appropriateness of accounting practices followed by firms and individuals in Britain has been a challenging task. The development of British accounting principles has been examined in the literature. In this context, it is noticed by Bryer (1998, 55) that ‘during the second half of the nineteenth century British legal judgements did not produce a coherent body of laws on accounting based on consistent and generally accepted principles of profit measurement and asset valuation’. British government should be also considered as responsible for the development of various accounting practices across the country. On the other hand, it seems that specific trends are followed by the country’s governments regarding the design and application of accounting principles through the years. Towards this direction, it is noticed by Beresford (2005) that ‘the market is subjected to systematic cost-benefit analysis to see whether a pattern of redistribution of profit (gains) to the market has been accompanied by losses (costs) being laid at the door of the state/public sector’ (Beresford, 2005, 464). On the other hand, Norris (1980) made clear that ‘the methods used in the preparation of accounts are influenced by many unscientific factors; chief among these are, firstly, the desire amongst directors to give very little real information to the shareholders and secondly the requirements of taxation regulations’ (Norris, 1980, 2). Under these terms, when a firm’s financial statements are to be interpreted many issues have to be taken into consideration – apart from the financial information provided through the specific statements. Two specific types of financial statements are going to be examined in this paper, the profit and loss account and the cash flow statement. It should be noticed that current paper refers to the forms and the characteristics of these statements as they appear in firms operating in Britain – despite the fact that many similarities are expected to exist with other firms operating globally under the terms already explained before. 2. Profit and Loss accounts of UK firms – analysis and evaluation All financial statements should be based on data presenting the firm’s actual financial position; no differentiation of these data is permitted otherwise there is a risk for misleading the market (including the firm’s shareholders) for the firm’s position and its financial strength. The responsibility of the firm’s accountants is therefore high; the latter should be careful when preparing a firm’s financial statements making sure that all figures included are supported by relevant documents. Because of the risk involved in this task appropriate insurance schemes have been developed through the years protecting accountants in cases of failure when completing a firm’s financial statements; these schemes also provide protection to the firm (cover of the damage caused because of the submission of faulty financial statements – even if the responsibility belongs solely to a firm’s accountant). On the other hand, it seems that there is ‘no evidence that the availability of insurance increased auditors’ risk by opening the floodgates of litigation’ (Chandler et al., 2005, 13). The development of a firm’s profit and loss account should be therefore based on specific principles (as in the case of all financial statements); because of its importance for the identification of a firm’s position in the market the profit and loss account should be carefully reviewed by the firm’s managers as of its appropriateness and the validity of the data included. In order to understand the importance of a firm’s profit and loss account it would be necessary to present primarily its definition/ description in accordance with the current literature. In this context, it is noticed that ‘profit and loss is the means by which an accountant – and owner of a company – can keep an accurate account of what money is coming in and going out of the business and also what money is not being spent wisely or recouped’ (Inventor Resource, 2008, online article). Through a different point of view, it is noticed that the profit and loss account ‘shows the final outcome of the firms trading over the past financial year’ (Guardian, 2007, online article). Other potential descriptions could be employed in order to explain the role of the profit and loss account in the development of modern firms. In its most common form a profit and loss account includes the following sections (as these sections refer to specific corporate activities): ‘a) sales, b) gross profit, c) direct costs, d) indirect costs and e) net profit’ (Inventor Resource, 2008, online article). Additional sections, like the earnings per share (referring to the earnings for the firm’s shareholder in accordance with the price of the firm’s shares – when an increase in the price of the share has been achieved) could be also exist. A more analytical explanation of these sections should be developed as follows: a) Sales The figure included in this section shows the total amount of money resulted from the sales of the firm’s products/ services to the public. No deductions can be made on this figure (at this part of the profit and loss account) because of tax – the figure should represent the money received as of the sales of the firm’s products/ services and any deduction for tax, VAT etc. could be presented in other sections of the profit and loss account. b) Gross profit This figure is resulted when all direct costs of sales (refers to all costs related with the products/ services in order for the product/ service to be offered by the firm in the market, e.g. cost of the product acquisition – if it has been bought by a wholesaler, and so on, see explanation below) have been deducted from the Sales figure (presented in the previous section). c) Direct Costs As noticed above, the direct costs are all the costs related with the product/ service up to its disposal/ offer to the public. They can include costs of acquisition (if the product was bought by a wholesaler), costs of packaging, storing and so on. The direct costs have to be deducted from the Sales figure in order to retrieve the Gross profit of a firm d) Indirect Costs These are also related with the product/ service but indirectly (difference from the direct costs). They can include the salaries/ wages of employees, various bills of the enterprise and so on. e) Net profit After the direct and indirect costs are deducted from a firm’s Sales figure, then the firm’s net profit is resulted. The explanation of the above sections of a profit and loss account can be differentiated in accordance with the type of analysis required. The general context of each of the above sections remains the same in any case; however additional remarks could be possibly made in order to refer to various parts of the firm’s activity. In this context, referring to the case of the direct and indirect costs presented above it is supported that ‘the distinction between direct and indirect costs also depends on the cost object; a cost can be treated as direct for one cost object but indirect in respect of another’ (Drury, 2001, 22). The use of each one of these sections of the profit and loss accounts can lead to the differentiation of their explanation when specific assumptions are required regarding the firm’s performance. An example of profit and loss account is presented in Appendix section (Figure 1) and will be used in section 4 in order to identify the key differences between the specific financial statement and the Cash flow statement. 3. Cash flow statements of UK firms – main characteristics Cash flow statements of modern firms present the amount of cash available as well as the amount of cash disposed to the various corporate activities. Differentiations can be also observed in the specific financial statement (as in the case of profit and loss account statement explained above); however there are also specific categories that have to be necessarily included in the specific statement. In any case, the level of cash available to any organization is a significant criterion for the development of the various corporate projects; cash budget, which is a strategic tool for the measurement of the firm’s performance, can be used in order ‘to ensure that sufficient cash is available at all times to meet the level of operations that are outlined in the various budges’ (Drury, 2001, 300). The various sections of a cash flow statement (see also Appendix section, Figure 2) can be analyzed as follows: a. At a first level, a firm’s cash flow should refer to all amounts of cash gathered through the various business activities b. At a next level, the cash required for the development of the business activities should be also presented in order for a total amount of the cash remained to be presented c. All cash flow statements have to include the amount of cash available at the beginning of the particular financial year d. It is also possible that a cash flow statement includes that amount of cash expected from the sales of the firm’s assets e. All the orders of customers that have been placed in advance (and have been paid in advance) should be also clearly presented (as a total amount of the money received for these orders) in the cash flow statement f. Any loan expected to be received in the financial year to which the cash flow statement refers it should be also included in the specific statement g. The firm’s owners can also raise money for the completion of various business projects through offering a specific interest of the business to the public; in this case the amount of money received through the disposal of this firm’s interest should be included in the cash flow statement h. The amount of money that have been gathered through the above initiatives should be clearly presented; this will be the total cash available for the realization of the firm’s strategic plans i. In the cash flow statement the amount of money paid to the firm’s employees should be also presented – any benefit paid additionally to employees could be included in the specific figure j. All firm’s operating expenses should be also presented in the firm’s cash flow statement – in order to help to the identification of the amount of cash left available for the firm’s various operational activities k. Expenses like payments of existing loans, purchase of assets and payments of tax should be presented – in separate sections – in the firm’s cash flow statement l. When all cash required for the payment of the firm’s obligations (as described above) is deducted from the cash available to the firm then the cash flow figure will be resulted. This will be the cash left to the firm after all payments to the firm’s stakeholders or to the third parties (banks etc.) are made. 4. Information provided to users through the Profit and Loss accounts and Cash flow statements of UK companies – presentation, analysis and evaluation It is proved through the issues developed above that a firm’s financial statements can be used in order to support various business projects; as an example, when the expansion of the firm is attempted then the funds required for the achievement of this target will be retrieved using the firm’s financial statements (that include all necessary information for a firm’s position in the market, its financial strength and so on). On the other hand, it should be noticed that the information provided through the firm’s profit and loss account are different from the one provided through its cash flow statement – at least the structure of these two statements is differentiated because in their general context one could claim that they provide information of similar content to the public. As explained above, a profit and loss account is consisted from specific sections (each one of them has been analyzed above). These sections are necessary in terms that they should be included in all profit and loss account statements no matter the region where a firm is established. Therefore, all assumptions related with the specific two financial statements of modern firms can be applied to firms operating in Britain. Particular remarks could be made regarding the information provided to the public through the above mentioned financial statements. In this context it should be useful to refer (separately) to the value of the information provided through the profit and loss account statement and the cash flow statement for the development of the various business projects. The information provided through a firm’s cash flow statement can be used in order to evaluate the firm’s position in its market. In this case, it would be valuable for the relevant figures to be compared with the figures included in other financial statements of the firm, especially those of the profit and loss account statement. More specifically, it is noticed that ‘the cash from operating activities is compared to the companys net income; if the cash from operating activities is consistently greater than the net income, the companys net income or earnings are said to be of a "high quality"; if the cash from operating activities is less than net income, a red flag is raised as to why the reported net income is not turning into cash’ (Accounting Coach, 2008). In other words, a firm can be characterized as successful or not within its industry in accordance with the figures included in its cash flow statement and its profit and loss account statement. Specifically the two figures mentioned above, the cash from operating activities (included in the cash flow statement) and the net income (included in the profit and loss account statement) are of critical importance for the identification of the firm’s position in the market and its potential to respond to the needs of specific projects. Another issue that should be noticed is the fact that both the figures presented in a firm’s profit and loss account and those included in its cash flow statement are necessary for the appropriate measurement of the firm’s performance; in practice the figures included in a firm’s profit and loss account seems to be preferred when having to measure the effectiveness of a firm’s strategic plans. It is for this reason that in ratios related with the firm’s activities the figures required are mostly those included in the firm’s profit and loss account. On the other hand, the cash flow statement of the firm can give accurate information on the firm’s financial position presenting all profits and expenses. Indeed, in the profit and loss account statement it is possible that specific expenses (like those for the acquisition of assets) are not included. In this context, the cash flow statement of the firm would be necessary in order to develop credible assumptions on the firm’s performance both in the short and the long term. Through a different point of view, it could be stated that a firm’s profit and loss account could be used in order to obtain a general view on the firm’s performance – comparing its profits and its expenses. The administration of the various firm’s obligations (payments owned to shareholders, employees and third parties) cannot be identified unless the cash flow statement of the firm is used. It is for this reason that the two most common types of financial statements used by managers and business analysts worldwide are the balance sheet and the profit and loss account statements. Cash flow statements are used in order to retrieve information on the firm’s particular activities, like the acquisition of assets or the orders pending to customers (orders made and been paid but not yet completed). 5. Conclusion In modern business market, a firm’s financial statements are used in order to identify the firm’s position in the market but mostly its potentials for future growth. Especially in the case of specific corporate agreements, like the mergers and acquisitions that are quite common in modern market, the use of a firm’s financial statements is quite necessary in order to identify a firm’s financial strength and its prospects for future growth. All assumptions made above are applied in the case of firms operating in Britain as there are no particular differentiations in the British firms regarding their profit and loss account or their cash flow statement. In this context, the structure of these two financial statements of the British firms could be similar with those of firms operating internationally (the examples provided in the Appendix section indicate the structure of these two financial statements as they can be observed in modern firms). Of course, in case that serious corporate decisions are to be taken, it would be necessary for the information presented in these two statements to be compared with the figures included in all other financial statements of the firm involved. References Accounting Coach (2008) Cash Flow Statement, online, available at http://www.accountingcoach.com/online-accounting-course/06Xpg01.html#statement-of-cash-flows-wha Beresford, P. (2005) Redistributing profit and loss: the new economics of the market and social welfare. Critical Social Policy, 25(4): 464-482 Bryer, R. (1998) The laws of accounting in late nineteenth century Britain. Accounting History, 3(1): 55-94 Chandler, R., Fry, N. (2005) Audit Failure, litigation, and insurance in early twentieth century Britain. Accounting History, 10(3): 13-38 Drury, C. (2001) Management Accounting for Business Decisions, 2nd ed. London: Thomson Learning Inventor Resource (2008) Profit and loss account, online, available at http://www.inventorresource.co.uk/profit-and-loss.html Guardian (2007) Profit and Loss Account, online, available at http://www.guardian.co.uk/business/2007/apr/12/businessglossary91 Norris, H. (1980) Accounting Theory – an outline of its structure. London: Pitman Appendix Reuters - Consolidated profit and loss account Notes 1998 £m 1997 £m 1996* £m Revenue 2 3,032 2,882 2,914 Operating costs 3 (2,482) (2,341) (2,322) Operating profit 550 541 592 Profit on disposal of fixed asset investments 26 – – Loss from associates (1) (1) (7) Income from fixed asset investments 3 6 6 Net interest receivable 4 2 80 61 Profit on ordinary activities before taxation 580 626 652 Taxation on profit on ordinary activities 5 (196) (236) (210) Profit after taxation attributable to ordinary shareholders 384 390 442 Dividends 6 (203) (190) (190) Retained profit 26 181 200 252   Basic earnings per ordinary share 7 26.7p 24.0p 27.3p Fully diluted earnings per ordinary share 7 26.6p 23.8p 27.0p Figure 1 – Reuters, Profit and Loss Account (source: http://about.reuters.com/ar1998/items/reuters_081.html) Figure 2 – Cash Flow Statement of Ansaldo STS (source: http://ansaldo.messageasp.it/en/2006/Annual_report/files/resourcesmodule/1208269401_Analysis_of_the_profit_and_loss_statement_and_the_balance_sheet_of_the_parent_company.pdf) Read More