The Role of Financial Statements and Financial Analysis for Organizations - Case Study Example

TITLE by Name of author Name of class Name of Professor Name of school Location of school Date Executive summary Financial analysis is important for every organisation. However, issues arise regarding the preparation of financial statements and eventual financial analysis. It is important to mention that effective financial analysis depends on sound preparation of financial statements. The balance sheets, income statements and cash flow statement are the most important financial statements to the company as well as shareholders. As such, it is important that financial accountants maintain high levels of ethics. To do this, competent personnel is required as they dictate what is recorded in financial statements, which will be used to monitor company performance. The issue of ethics cannot be over emphasized enough. The International Accounting Education Standards Board through its International Education Standards have proposed that education programmes for future financial accounting professionals need to emphasize on ethics, values and attitudes. This will enable the body to develop financial accounting professionals who are above reproach in ethical issues concerned with financial accounting. This report then gives a good example of Satyam that collapsed as a result of falsifying their balance sheets. The company’s board failed to place ethical measures that would have prevented the fraud that happened. Introduction Financial statements area very crucial to any organisation, from small and medium enterprises and big companies to multinational corporations. However, despite their importance to organisations, the usefulness of financial statements will be lost if the information they provide is not interpreted carefully and precisely by those tasked with financial statement analysis (Periasamy2009). In most cases companies have gone out of business because the process of financial statement analysis was either not done correctly or organisations’ financial officers underestimated the importance of proper financial statement analysis. In the financial arena, there are va4rious methods of analyzing financial statements because different facets are combined to get the overall performance of a company. It would be detrimental to rely on a single method of financial statement analysis as the results may not provide the organisation adequate information on the overall performance of the organisation. It is thus important for the accounting officers to employ the use of different financial ratios that will provide information on different financial fronts of the organisation (Robinson, Munter& Grant 2003). Making sure that the organisation understands the importance of financial statements is one thing. It is also another thing employing quality personnel that will ensure that raw data from financial statements are well interpreted. Organisations must therefore not compromise when hiring accounting officers as they are responsible in guiding the organisation towards financial success (Bernstein& Wild2000). Most successful companies and businesses all have one thing in common; they have competent personnel who can readily deal with financial analysis issues and give the management simplified information. This financial information will be used to make strategic decisions regarding the organisation’s vision. It is therefore paramount for organisation to have good financial analysis systems and competent personnel who understand those systems for better performance and in order to keep pace with the competition (Robinson2012). Balance Sheet, Cash Flow Statement and Income Statement Balance sheets are financial statements that are used by organizations to determine its financial position. It reveals the companies assets, liabilities, and net worth. The cash flow statement on the other hand shows how cash flows through the organization and what it is committed to (Barone & Kothari 2006). The balance sheet, cash flow statement and the income statement, when combined together, form the cornerstone of the organizations financial statements. These are the most important statements for the organization’s stakeholders. For a good and clear analysis, the balance sheet must balance out on the two sides (credit and debit sides). This is the major reason why it is called a balance sheet. It is important to note that a balance sheet will differ from one company and industry to the next as there isn’t a single uniform statement that will cut across all companies and industries (Barone & Kothari 2006). The cash flow statement on the other hand is a financial statement that complements the balance sheet and the income statement and it is compulsory for all organizations to have a cash flow statement. The basic work of a cash flow statement is that it records how cash leaves and enters the company. It also records where company’s cash come from and what it is being spent on. Cash flow has three main components which are operations, investing and financing (Barone & Kothari 2006). On the operations components, it is important to note that a company’s operations are what generate cash as well as what cause cash to be spent. In investing, any changes in equipment, assets or investments are directly related to cash. Cash change as a result of investing is categorized as cash out since cash is used to by new equipment for the organization or market securities. When the organization decides to divest, it is considered cash in as the company makes money from such divesting. In financing, the changes observed in debts, loans or dividends are usually taken care of by cash from the company’s finances. The consequent of this is that the company reduces its cash reserves Ethics in Financial accounting Ethics forms the core of any business operation. Businesses that are well performing on the financial side are also well performing on the ethics side. Microsoft is a good example of an ethical firm (Hoffman 1996). The company has spent millions of dollars in charity and it is still making huge profits. Ethics in financial accounting is a field in applied ethics and includes the study of moral values in the application of financial accounting procedures as well as in judgments in accountancy. Financial accounting ethics is a form of professional ethics. Recent corporate collapses as a result of unethical practices in financial accounting has seen companies adopt strict financial accounting ethical values that resonate all across organizations. Ethics in financial accounting has been considered by many as difficult to control for the very simple fact that it relies largely on personal morals and values. Therefore, companies with strict ethical measures put in place but with accounting employees who are unethical will suffer the consequences that come about as a result of unethical financial accounting. Ethics thus plays an important role in financial accounting, specifically for financial accountants. These professionals need to be ethical in the way they carry out their work due to the very nature of their professions (Hoffman 1996). Financial accountants are in a special position in the organizations as internal and external stakeholders put their trust on them. As such, it becomes important that they do not betray this trust for the good of the company. Making sure that the highest ethical standards in financial accounting are upheld by the organization should be one of the most important goals for an organization. The fiduciary relationship between financial accountants and the people they work for demands that financial accountants dispense their duties within the ethical values of honesty, due diligence, objectivity and integrity. Al these should be aimed at the public first. The ‘Framework for International Education Standards for Professional Accountants’ identifies that the primary objective of financial accounting education is to develop financial accounting professionals who are not only competent but also ethical. In this respect therefore, the International Education Standards – Professional Values, Ethics and Attitudes of the International Accounting Education Standards Board puts forth a recommendation that a professional accounting education programme should be able to provide future financial accounting professionals with a strong framework of values, ethics and attitudes. The need for ethics in financial accounting can therefore not be over emphasized. This is because financial accountants have access to crucial information and the nature of their profession is such that they need to be trustworthy. In addition, companies and clients spend millions of dollars as in the form of investments meaning that these stakeholders invest more than their trust (Hoffman 1996). It is therefore paramount that financial accountants have strong ethical values than just knowing what is right and what is wrong. Strengths and Weaknesses Strength Collective Bargaining Purposes The importance of financial statements cannot be overemphasized. While they are important to the good performance of an organisation, employees of the organisation need them to make collective bargaining agreements with a company’s management. Collective bargaining is usually instigated by unions for the purposes of ensuring that company employees are remunerated according to the organisation’s performance (Pandey& Pandey2009). As a result, financial analysis needs to be precise in order to portray the company’s true position, especially financially. This will thus call for proper preparation of financial statements by competent personnel using financial analysis methods that are up to date. Aid in Strategic Decision Making This is another strength of financial statements and their analysis. Companies need information such as the cash flow, net worth of the company as well as how much income the company is getting. This helps the company make strategic decision on investments, hiring, venturing into new markets and so forth. Without financial statements, companies would be in the dark as to what decisions to make to allow it become competitive in whichever industry it operates in. Weaknesses Financial jargon Financial jargon is also another issue in the financial filed that makes preparation and interpretation of financial statements a tough task. It is always the objective of a company to prepare financial statements and analysis statements that will be easily read by every stakeholder, both external and internal. However, in the judgment of most financial analysts, the information analyzed will only be used by those people who know how to interpret financial information (Beaver, Correia & Mcnichols 2011). As such, you will find that financial analysts using financial jargon that most people do not understand. Although this information will in most cases be interpreted to people with limited knowledge in accounting, such interpretation will still need basic knowledge in accounting. Furthermore, complete lack of knowledge is likely to blind a person if the interpretations being made are false. If that is the case, then such a person will definitely not know that he or she is being presented with false information. Companies therefore try their level best to prepare and present financial statements in a way that they can be consumed by both seasoned investors as well as raw investors. It should be noted that the decision to make investment decisions lie with the investor and not the financial institution transacting on the investors behalf. Therefore, if less financial jargon is used for the sake of the public, the public will benefit more and will feel empowered to making sound financial decisions (Beaver, Correia & Mcnichols 2011). If on the other hand, this trend by financial analysts persists, then the power to make investment decisions will be left in the hands of the investing companies of shareholders. This will deny shareholders power to make their own investment decisions with little help from their investment companies. Looking at it from a different angle, the difficult jargons used in financial statement denies investors a learning opportunity. It is true that the main reason behind the use of a simplified language in financial statement is for stakeholders to understand by their own interpretation, the company’s position. However, stakeholders also need to have some reasonable knowledge in economic activities as well as accounting. Having good knowledge in these fields will complement the need to have accounting and financial language needed to make sound investment decisions (Robinson, Munter& Grant 2003).The best resource that a company can have is a knowledgeable and informed stakeholder. This, however, can only be achieved by ensuring that judgment related to presentation of financial statements and analysis is not made on the basis that such information will be interpreted on behalf of the stakeholders. Different financial policies Companies and organisations have different financial policies and it is important to take note of this during financial analysis. While some companies will fund themselves with long term borrowing, other will find it better to use shareholders’ funds or its reserves. The implication of this is that making ratio comparisons on two companies with different financial policies will only lad to misleading the CEO and others with limited knowledge in accounting. Information that is meant to help in making crucial decision will alternatively lead to making poor decisions regarding investments, company financial position, and company market value. Incomparable financial ratios Although it was mentioned earlier that ratios should be compared against each other to give a clear picture of the company’soverall performance, it should be noted that not all rations are comparable. When comparing a company’s financial ratios to another company, the other company’s price levels must be comparable; otherwise the analysis will not make any sense at all. For instance, if a company sales its products at 50% more than your company and keeps its operation costs low, measuring your company’s profitability with this company will yield results that will in no way be useful to your company. It would thus make sense if judgment on financial ratio analysis was made on the basis of comparable variables. Additionally, such analysis must be conducted using similar accounting methods. Different regions and economies have different ways of conducting financial analysis and preparing financial statements (Organisation for Economic Co-operation and Development 2005). It is therefore important for companies to know that in analyzing financial ratios, the accounting methods they use must be similar to those of the region or market. For instance, a company in the United States will only get useful results if it compares its ratios to that of another company in the country. Comparing its ratios to a company in Cuba or Argentina will beat the purpose of the financial analysis exercise. Case Studies A good example in the application of financial statements and ethical issues in financial accounting is in the way SATYAM conducted its financial operations. Satyam was a company that was established in 1987 and was a fast growing IT company in India. It has 9% market share with 53, 000 employees and it was worth $2.1 billion. Additionally it was the first Indian company to be listed in NYSE, DOW and EURONEXT. What happened in Satyam is that the company proposed to buy a stake in Matyas for INR 65 billion. One day later, the buyout was called off and then a day later, the board decided to buy back to keep investor trust. On 19th Dec 2008, a motion against Satyam is filed for alleged fraud. The World Bank then imposed an 8 year ban for data theft and bribery accusations. A report by PWC revealed that the company’s CEO had created INR 71.36 billion in fake billing and cash which the auditing company had missed in the cash accounts. The audit company did not confirm Satyam’s bank balances independently and this is the reason why the company was able to continue with their fraudulent manipulation of balance sheets. Later, the CEO confessed that the scam to create the fake billings was a result of account manipulations that dated way back. This scandal raised a few issues that touched on the investors, board of directors, government regulation, accounting standards and ethics and codes of conducts. All these entities must take due diligence in the company as they are all stakeholders. Investors must play n active role in the financial operations of the company they have interests in and it is them who are in a good position to detect financial fraud. The board too plays an integral role as it must monitor company ethical policies in addition to accepting only qualified board members into the board. The government on the other hand is supposed to formulate strong regulations and policies relating to financial accounting. Considering that PriceWaterhouse Coopers missed the fraudulent manipulation of Satyam balance sheets means that auditors need to carefully check the fairness and trueness of financial statements. This requires good audit tools and auditor freedom. Ethics was the last thing that was a priority for Satyam. The company corporate governance was poor, as was its fraud detecting mechanisms. It also lacked proper codes of conduct that would have held the CEO responsible for the fraudulent activities. Another excellent case study about financial planning involved the Commonwealth Bank. What happened in CBA is that financial advisers gave fraudulent and misleading information to customers who later lost their savings in the millions. Between 2003 and 2012, customers received poor advice by their financial planners in addition to forging signatures, overcharging investment fees, and creating unauthorized investment accounts for customers even without the permission of the customers. In 2006, Mr. Jeff Morris reported the fraudulent activities that were going on at CBA to the Australian Securities and Investment Commission (ASIC). The CBA case study is a good example of how the board of an organisation can fail customers and shareholder. The company was operating in a glaring flawed compliance framework with the board encouraging an aggressive sales culture. This gave the company’s financial planners an opportunity to push customers into wrong products which led them to losing millions in investments. In this case, the financial planners in the organisation lacked the ethical values relating to financial accounting. There were no measures put in place to ensure that such fraudulent activities could be easily detected. This was failure on the board’s part which led to a loss of confidence and this consequently reduced CBA’s shareholder value. The board itself enjoyed exorbitant amounts of salaries and bonuses and denied customers their compensations. Conclusion Financial statements and financial analysis are important to organisations. However, left alone as they are, they do not complete an organisation’s goal of serving customers ethically. It is thus important to ensure that organisations maintain ethical standards that are above reproach. It is not enough to have competent financial accountants to oversee crucial and private financial information. Ethics in financial accounting is indispensible. That being said, everybody involved with the organisation has a role to play in ensuring that organisations act professionally and ethically. Investors, the board, auditing companies, the government and professional bodies all have a part to play. References Periasamy,P 2009, Financial management. New Delhi, Tata McGraw-Hill. Pandey, I. M., & Pandey, I. M. 2009, Essentials of financial management. New Delhi, Vikas Publ. House. Organisation for Economic Co-operation and Development 2005,Improving financial literacy analysis of issues and policies. Paris, France, OECD. http://public.eblib.com/choice/publicfullrecord.aspx?p=514734. Gibson, C. H. 2009,Financial reporting & analysis: using financial accounting information. Mason, OH, South-Western Cengage Learning. Peterson Drake, P., & Fabozzi, F. J. 2012, Analysis of financial statements. Hoboken, New Jersey : John Wiley & Sons, Inc. Bernstein, L. A., & Wild, J. J. 2000,Analysis of financial statements. New York, McGraw-Hill. Robinson, T. R. 2012,International financial statement analysis. Hoboken, N.J., John Wiley & Sons. Beaver, W. H., Correia, M. M., & Mcnichols, M 2011,Financial statement analysis and the prediction of financial distress. Boston, Now. Robinson, T. R., Munter, P., & Grant, J 2003,Financial statement analysis: a global perspective. New York, Pearson Education. Maynard, J. 2013, Financial accounting, reporting, and analysis. Oxford, Oxford University Press. Barone, E., & Kothari, J. 2006, Financial accounting: an international approach. Harlow, England, Financial Times/Prentice Hall. Hoffman, W. M. 1996, The ethics of accounting and finance: trust, responsibility, and control: From the Tenth National Conference on Business Ethics. 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