Let me first begin by explaining what a cash flow statement is. To put it simply, a cash flow statement is rather self-explanatory in that it details the flow of cash in and out of the business. It shows where cash comes from and where the said cash goes to. For example, a typical cash flow statement would include cash generated from sales and on the flip-side, taxes that are paid. Another form of financial statement is the income statement. The income statement is also sometimes referred to as the profit and loss statement. As with cash flow statements, income statements are also rather self-explanatory. This is perhaps more apparent to the layman if they are referred to as profit and loss statements. These statements show whether a company is running on a profit or a loss for a given period. As with other forms of financial statements, balance sheets also reflect on the financial health of the company. However, balance sheets are typically much more comprehensive and often offer a more detailed look at a company’s financial standing. It details who owes the company what, who the company owes, and what properties the company owns, amongst other things. Equity statements on the other hand explains the changes in the company’s retained earnings. It would typically contain items such as changes in ownership stake in the company and the level of profit or surplus retained over a specified period. Also often detailed are dividend payouts and issuance of stocks. Now armed with some rudimentary knowledge of what financial statements are, we are perhaps better equipped to navigate towards the main focus of this essay – the importance of financial statements to various groups.
In no particular order, I shall first discuss the importance of financial statements through the lens of a prospective investor. As one might imagine, it would probably not be a very good idea to invest one’s hard earned money into a financially ill business. In a nutshell, this is why financial statements bare such great importance to the prospective investor. Financial statements provide a vital look into the inner workings of a business, painting a better picture of how the said business is run and thus helping investors better calculate risk. That in turn helps them make better investment choices, hopefully. For instance, an analysis of an income statement would show whether or not the target of investment is turning a profit. This, is probably as good a yardstick as any in assessing a companies success, at least on the surface. Cash flow statements are also of considerable importance to prospective investors as it displays the the movement of cash through the business. An investor could use the cash flow statement in tandem with the the companies net income to determine whether the volume of cash moving through the company is sufficient to make their investment efforts worthwhile. Balance sheets as discussed above, provide a snapshot of a companies financial wellbeing for a specific duration of time. Balance sheets thus provide integral data detailing the assets of a business which would include prior investments contradicted with the liabilities the business owes. Based on the assumption that no self-respecting investor would want to make a loss on his/her investment, the balance sheet would show clearly if the business in rolling in debt with not much prospect of profitability and that point in itself clearly underlines the importance of the balance sheet to investors. Equity statements like all other forms of financial statements really come in handy when trying to assess the financial standing of a company. Equity statements are used typically, but not exclusively, when deducing a company’s debt-to-equity ratio. The investor would look at the equity statement and draw a comparison between the company’s cumulative debt and the shareholders’ equity. This helps paint a detailed picture of a company’s financial health, specifically and for lack of a better word, its “investability”.
It is often said that a company is but only the sum of its employees. Having argued thus, it is a hardly debatable notion that financial statements are as important to individual employees as they are to anyone. Financial statements can help the individual employee gauge the stability of their current job and decide if it is necessary to perhaps seek greener pastures elsewhere. Now, this might not necessarily be good for the business in question, but from an employees perspective it is a perfectly valid point. Wouldn’t you want prior knowledge if the business you work for was free-falling down the financial hill? Additionally, these reports also come in handy when making bargaining agreements with the management in terms of remuneration, promotions and so forth. It is worth nothing, however, that it is these financial statements are more commonly reviewed by workers unions or similarly designated bodies rather that the individual employee himself. Specifically, balance sheets are important as it helps the employee assess the financial stability of the firm he or she is working for. For instance a registered union may review a companies balance sheet and notice that it has $500million in available cash. The union representative may then attempt to persuade the company to raise employee salaries by a margin realistically within the company’s financial parameters, say by 5 percent, knowing full well that the raise would only cost the company and additional $2million. A labor representative may also analyze a company’s income statement to weigh revenue and expense levels. Taking into consideration the breakdown of the income statement the representative could show, if it is the case, that perhaps salaries of employees only constitute a proportionally small percentage of the companies expenditure. The said representative could then advocate for a raise on behalf of the employees arguing that the cost involved with giving that raise would not adversely affect the company but rather benefit the firm by boosting the morale and hence effectiveness of its staff. Much of the same arguments as to why an employee or a union would want to review a business’ income statement conveniently also applies to cash flow statements. The differing point here being that what would be reviewed in a cash flow statement is the companies operating cash activities. Its importance towards the employee would be that cash flow statements would show the total cash payments against which total staff salaries could be compared with to gauge whether employees of the business are being fairly compensated. Equity statements on the other hand, are not of much use to the average individual employee. However, the same cannot be said for workers’ unions. As equity statements would detail things such as dividend payouts, it would show if the directors are being paid massive dividends at the expense of the average employee as was the case with General Motors during the automotive industry meltdown last year. Top execs were paid bonuses worth hundreds of millions of dollars while the company as a whole was so deep in financial quicksand that it required a bailout from the US federal government.
Thirdly, we shall consider the importance of financial statements from the perspective of lenders. As providers of capital, lenders namely banks and financial institutions are understandably very concerned with a company’s financial health as it reflects directly on the aforementioned company’s credit worthiness. Much like how you and I are required to produce income documents upon application of a loan or any other credit facility for that matter, company owners are also usually required to produce a whole bevy of financial statements before any form of credit is issued by the lender. These documents prepared to certain industry standards serve to paint as accurate a picture as possible of the company’s current financial standing and when extrapolated help predict how the company will perform for the tenure of the loan. The balance sheet, by detailing a company’s asset investments paint a great portion of this picture. Since the balance sheet also list a company’s outstanding debt and equity components, it helps creditors assess their relative position amongst the rest of a company’s capital composition. On the other hand, profit and loss statements or income statements, are of much use to creditors as it would show whether a company has sustained growth or suffering a loss over a specified period. This then assist the lender in plotting the trend which they will then use, in conjunction with other factors to determine how well the company will be able to repay the loan. As with other financial statements, cash flow statements also prove to be of great importance towards creditors in much the same way as the other forms of financial statements discussed above in that it paints a picture of a company’s credit worthiness. However, it is worth noting that a paradox exist when it comes to cash flow statements and its relationship with lenders. The more detailed the cash flow statement is, the less likely the applicant business has anything to hide. Bearing this in mind, the cost of preparing a financial statement rises exponentially with the level of detail involved. This increase in cost is associated with the practical and logistical constraints of compiling every single cash transaction that the business undertakes. Thus said, it is of utmost importance that businesses strike the golden balance between cost and providing lenders with a sufficient cash flow information within the statement.
Apart from the aforementioned parties, suppliers also have an interest in the analysis of a company’s financial background via financial statements. Suppliers and vendors rely on the statements to asses the financial standing of clients, especially those they intend on establishing a long-term relationship with, to ensure that they are not getting into a bad deal. However, setting themselves apart from the parties discussed above, suppliers tend to rely more on statements containing information on the business partners or owners. The underlying principle behind this phenomenon is the fact that in a trade environment where it would be logistically impossible to check their customer’s backgrounds in its entirety, credit risk on the part of supplier simply skyrockets. This information is typically used as part of the suppliers’ due diligence and compliance processes, which are crucial in identifying the risk involved in transacting with a particular client. When these processes are undertaken are largely dictated by the suppliers themselves, however it may also be determined by government or industry regulators. For example, when not governed by regulation, a supplier may choose to play it safe by implementing due-diligence processes prior to establishing a relationship with the client business or only once transactions hit a certain threshold to give clients a chance to sample a vendors goods or services. Another peculiarity with the way vendors or suppliers utilize financial statements is that they generally tend to rely on specific, isolated bits of informations within these statements when financially profiling their clients. These bits might take the form of bankruptcy flags deduced from balance sheets, liquidity data inferred from cash flow statements and even financial statements with an internal focus which they then use to evaluate whether a client’s business model is a potentially profitable or otherwise. However, where available, income statements would be favourable as they negate the need for guess work in determining a client business’ profitability.
Moving on, we shall now consider the importance of financial statements towards the stakeholders perhaps most coveted by businesses – the valued customer. Whilst the layman would rarely look into each type of financial statement in isolation, when consolidated and simplified, perhaps into a financial report or an article found in he business section of the daily paper, the information in financial statements can be extremely useful to the consumer. Allow me to illustrate my point. Consumers no doubt prefer doing business with well established companies as these businesses generally offer better after sales service and customer support. However, in some sectors like the automotive and real estate industries, longevity in a company is often at top of a consumers priorities when faced with the choice of who to do business with. Information hypothesized from financial statements provide this valuable insight. Another prime example I shall use to fortify my point has to do with the recent surge in environmental awareness. Today, more consumers than ever are demanding that companies behave socially and environmentally responsibly. As a direct result, more and more companies are incorporating such metrics into their financial documents to reflect this much desired virtue.
Lastly, a company’s financial statements also play an irreplaceable role to the governments of the nations in which the companies operate. It is common knowledge that a great portion of a government’s income comes from corporate tax paid by businesses that operate in that country. Thus, financial statements allow governments the luxury of calculating future budgets by way of approximating the taxes that each company would pay based on its prior and projected performance. In more detail, companies’ balance sheets are scrutinized by government agencies and regulators to ensure that companies are being run in compliance with legislation passed by the government. On a darker note, law enforcement often analyzes the cash flow statements of companies as it details the migration of cash in and out of the company. As such, this document would be as good as any when looking for evidence of money laundering.
Dearest reader, much ink has been spilled by both scholars and members of industry alike in an effort to classify financial statements into various groups. Although this has largely been a successful endeavor as discussed in the foreword of the essay, the more minute details of what each “type” of financial statement is remains till this day a subject of debate and interpretation. Perhaps, though, a more futile question to ask is “to whom are financial statements important?”. To that question and in concluding this essay, I humbly opine that while financial statements are important to several major groups as outlined throughout the essay, on a broader scale, these mere pieces of paper with numbers jotted across them would be of great importance to any group or individual with an interest in the economic aspect of any particular company.
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