Risks Associated by Sources of Finance in China - Literature review Example

BE110 FINANCIAL REPORTING & ANALYSIS Contents Contents 2 Introduction 3 ‘Financial ments provide comprehensive information about the reporting entity that is useful to existing and potential stakeholders’: Discussion 3 Critically analyze the general purpose of financial statements while considering the information provided in the key components of financial statements 6 Conclusive Summary 9 References 10 Introduction The usefulness of the financial statements of the reporting entities from the point of view of the stakeholders has been reviewed along with the purpose of the data and information reported on the financial statements has been reviewed. The importance of reporting comprehensive information for the protection of the investors and the stakeholders has been analyzed with the analysis of past example of financial fraud. The importance of capital maintenance and subsequent reporting of the debt, liability and equity in the financial statements has been established in this work. The general purpose of the financial statements has also been explained with the analysis of the key components reported in the various parts of financial statements. The various financial concepts have been reviewed and linked with various examples in the analysis of financial statements and its purpose. ‘Financial statements provide comprehensive information about the reporting entity that is useful to existing and potential stakeholders’: Discussion The financial statements prepared by the companies are reported with comprehensive data and information on the reporting entities. The exhaustive data and information reported in the financial statements with the purpose of disseminating useful insight on the capital maintenance of the company to their shareholders. The shareholders may be classified into existing and potential investors who track the financial statements reported by the companies as a reliable means of measuring the performance of the company (Briloff, 1981, p.75). The exhaustiveness and accuracy of the information reported through financial statements are, therefore, extremely important as the investors and the shareholders decide on their future investments and stock positions based on the performance of the entities reflected in the financial statements. The shareholders are also able to understand the relative control of the ownership structure and the external stakeholders which is important from the perspective of operational control of the business. The review of the literature in the reporting of financial statements of the entities in various industries, sectors and markets all over the world reveals that there have been significant lapses in the reporting of true financial statements in quite a few occasions. These companies were also not able to adhere to theory of capital maintenance as they incurred high level of debt as compared to the equity base of the entities (Cousins, Mitchell, Sikka and Willmott, 1998, p.64). The high volumes of debt were not viewed to be positive from the point of view of the investors as they would not invest in entities with inferior capital maintenance. The examples of Enron, WorldCom, Satyam Computer Services, etc. resemble the consequences of reporting false capital structure and inflated financial statements. These examples also explain the importance of true and comprehensive information reported in the financial statement from the point of view of the existing and potential stakeholders of the entity. The board of directors of Enron allowed hiding of the huge debts of the company amounting to $1bn. The management also reported inflated profits in their financial statements that misguided the investors and the shareholders of the company. The WorldCom management reported inflated cash flow statements by adjusting the operating expenses amounting to $3.8bn in the column of capital expenditures. The management also reported a loan of $400m to their founder (Badawi, 2008, p.4). Satyam also reported inflated financial statements. All these activities were attempts made by the managements in reporting financial statements with an inflated view for the stakeholders in order to sustain the demand of their market shares. However, these financial frauds led to bad investments by the potential stakeholders and the companies themselves went bankrupt and undergone legal proceedings. These incidents in the arena off financial reporting led to the measures from the regulatory authorities to ensure true and fair reporting of financial statements of the entities (Sikka, Willmott and Puxty, 1995, p.116). In order to ensure that the financial statements contain true and fair reporting of financial accounts and other figures and data, the Sarbanes-Oxley Act was introduced in the US capital markets. The companies listed in the US stock exchange were required to follow the guidelines of the Sarbanes Oxley Act to continue listing in the US stock exchange and carry out operations. The regulatory bodies in the financial markets all over the world also introduced measures that led companies to report true, fair and comprehensive information contained in the financial statements. These measures were useful and significant from the point of view of protecting the interests of the existing and potential stakeholders. The restrictions were put in order to ensure that the entities maintained their capital structure on a continuous basis. The level of maximum debt that could be incurred by the companies was limited in proportion to the equity. The companies were required to report the true and fair value of the debt and equity levels of the company. This ensured the protection of the investors from the fact that they were able to understand the accurate gearing ratios of the reported entities. According to the Sarbanes-Oxley Act, the reporting entities are also required to conduct preparation of statement of accounts at a fair value and apply judicial ethics while preparing the financial statements. The accountants and auditors were also assigned the responsibility of not being influenced under the pressure of the management and apply accounting ethics while preparing the financial statements. The information on the capital structure, assets and liabilities, debts, capital expenditures, investments, equity etc. are reported in a comprehensive manner with notes as required for explanation of the financial position. Thus the reporting of financial statements containing comprehensive information on the capital maintenance has given the existing and the potential stakeholders with useful access of the financial data of the company. The comprehensive nature of financial statements of the reporting entities provides deep insight of the exact position and performance to the stakeholders and the investors of the company. The interests of the investors are protected against the possible measures of manipulation in the financial statements. The comprehensive financial statements could be analyzed and the investors could take informed decision on investments in the shares and stocks of the companies. The existing stakeholders could also judge the performance of the entities through the analysis of the financial statement and gain an understanding on the short term and long term prospects for growth. The stakeholders of the reporting entities could decide whether to extend or reduce their stockholding position. The comprehensive data on capital maintenance reported in the financial statements are useful for the stakeholders and the investors as they could realize the future return based on the precise assessment of the risk factors (Bhattacharyya, 2011, p.59). Critically analyze the general purpose of financial statements while considering the information provided in the key components of financial statements The analysis of the general purpose of the financial statements could be revealed through the review of the literature and examination of the key components in the financial statements. The general aim of the financial statement reporting of the entities is to provide a fair and actual view on the performance of the entities to the internal and external stakeholders of the company. The entities view the comprehensive data reported in the financial statements as the indicative instruments on the investment decisions, liabilities undertaken and assets acquired for the sustainable growth of the companies (Jackson, Sawyers and Jenkins, 2008, p.74). Through the reporting of financial statements, the management fulfils the purpose of communicating the internal and the external stakeholders that the companies have the primary objective of maximizing the wealth of the shareholders through the undertaking of calculated risk and return. The financial statements reveal that the investment decisions undertaken by the companies are in accordance with the risk-return trade theory in finance. The information on the various risks associated top the business performance of the company including the foreign exchange risk, interest rate risk, credit risk, liquidity risk, etc. are included in the notes to the financial statements (Warren, Reeve and Duchac, 2008, p.82). This provides an idea of the effectiveness of the management decisions taken by the company in investments, undertaking of liabilities in order to maximize the return on assets and equity. The overall purpose of the financial statement could be better explained by the consideration of the information presented in the individual components. The review of financial statements of several multinational companies listed in the Fortune 500 list of companies like Wal-Mart, Exxon Mobil, Philips, Ford Motors, Berkshire Hathaway reveal that the financial statements comprise of income statements, balance sheets and cash flows of the reporting entities. The income statement reported by the entities reveal the position of the sales and revenues of the company in the current fiscal as compared to the last fiscal. The purpose of the entity is to communicate the stakeholders of the acceptability of the products and service to its customers. The cost of goods sold for the last two fiscals that includes the current fiscal is reported by the companies in their income statements (Khan, 2004, p.45). This fulfils the purpose of the entity to communicate the effectives of the management in controlling the cost of production and service which plays an important role in determining the profits earned by the company. The investors and the stakeholders view various other costs incurred by the entity like the operating costs, administrative costs, interests and taxes paid. The net profits earned by the company are important with respect to the consideration of the stakeholders of the company. The various costs reported in the income statement helps the entity to communicate the efficiency of the management in controlling the cost incurred in their business. The balance sheet components are also useful means of communicating the position of assets and liabilities of the entity to the stakeholders and the investors. The total assets are reported by the companies with two sub-components namely, the current assets and the non-current assets. By reporting the current assets of the entity, the management fulfils the purpose of communicating the short term position of liquidity of the company to their shareholders and the investors (Baker and Powell, 2009, p.91). The non-current assets are reported in the balance sheets in order to communicate the long term asset position of the company. The other part of the balance sheet is formed by the liability section. The total liabilities are again divided into current liabilities and non-current liabilities. The current liabilities are reported to provide an idea to the investors of the debt incurred in the short term. The long term liabilities are reported with a purpose of informing the stakeholders of the long term debts to be repaid by the company. The management is able to provide the information the stakeholders and the investors on the level of liquidity of the company to service the short term and long term liabilities. The equities are also reported following the equation: Assets = Liabilities + Equity. The position of equity is reported by the company with a comparison of the previous fiscal in the balance sheet so that the prospects of the company to maximize the shareholders’ equity in future could be communicated to the users of the financial statements (Dickie, 2006, p.37). The dividend paid by the company is also revealed in the financial statements. The dividend payments are supported by the dividend theory of Bird in Hand which states that the company would continue to pay dividends with the residual profits retained by the company after incurring all expenses. The dividend payments are declared with the purpose of informing the investors of the future growth prospects of the company. Conclusive Summary From the review of the literature on financial reporting and analysis, it has been revealed that that the comprehensive data and the financials reported in the financial statements are useful for investors and shareholders. The fair and true information reported in the financial statements could be analyzed by the investors and the existing shareholders to take informed decisions on investments. The information on capital maintenance provides the gearing ratios to the stakeholders that enable them to interpret the control of the internal and the external stakeholders. The general purpose of the financial statements as observed from the review of the key components reveals the changes in the assert base and the liabilities with respect to the previous fiscal. The information on the equity and dividends provide the investors with the idea on growth prospects of the company. References Briloff, A. 1981. The Truth About Corporate Accounting. New York: Harper & Row. Cousins, J., Mitchell, A., Sikka, P. and Willmott, H. 1998. Auditors: Holding the Public to Ransom. Basildon: Association for Accountancy & Business Affairs. Sikka, P., Willmott, H. and Puxty, T. 1995. The Mountains are Still There: Accounting Academics and the Bearings of Intellectuals. Accounting, Auditing & Accountability Journal. 8(3), 113-140. Badawi, I. M. 2008. MOTIVES AND CONSEQUENCES OF FRAUDULENT FINANCIAL REPORTING. [Online]. Available at: http://orgs.bloomu.edu/gasi/Proceedings%20PDFs/Badawi1.pdf. [Accessed on 21 January, 2014]. Dickie, R. B. 2006. Financial Statement Analysis And Business Valuation for the Practical Lawyer. New York: American Bar Association. Baker, H. K. and Powell, G. 2009. Understanding Financial Management: A Practical Guide. New Jersey: John Wiley & Sons. Khan, M. Y. 2004. Financial Management: Text, Problems and Cases,4e. Delhi: Tata McGraw-Hill Education. Bhattacharyya, D. 2011. Management Accounting. New Delhi: Pearson Education India. Warren, C. S., Reeve, J. M. and Duchac, J. E. 2008. Financial & Managerial Accounting. 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. Read More