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Critical Analysis On The Use Of Financial Statements In Accessing The Performance of an Organization

by Amarachukwu

According to the Merriam Webster dictionary, analysis is a detailed examination of anything complex to understand its nature or to determine its essential features as a thorough study.

An analysis breaks a complex subject or substance into smaller parts to understand it better. This technique has been applied in various ways, long before Aristotle.

Methods of Analysis

In finance, analysis can be applied in various methods which are;

Requirements Analysis

This method of analysis includes those tasks that determine the needs or conditions to meet for a new altered product, taking account of the conflicting requirements of the various stakeholders such as beneficiaries or users.

Critical Analysis On The Use Of Financial Statements In Accessing The Performance of an Organization

Both internal and external stakeholders of an organization make use of requirement analysis to evaluate the performance of the organization.

Worst-Case Execution Time

This analysis method determines the longest time a piece of software can take to run. 

Static Code Analysis

This analysis method involves computer software that is performed without actually executing programs.

Semantic Analysis

This analysis method involves a pass-by compiler that adds semantic information to the parse tree and performs certain checks.

Technical Analysis

This is the study of price action in security markets to foretell future prices.

Business Analysis

This method has to do with identifying the needs and deciding the results of business problems.

Gap Analysis

This method involves comparing actual performance with the potential or desired performance.

Market Analysis

This method only consists of suppliers and customers, which determines the interaction of supply and demand.

Fundamental Analysis

Fundamental analysis is a stock valuation method that uses financial analysis.

Opportunity Analysis

This analysis method consists of customers’ preference style within the company or industry, customer demand, and experience determining purchasing behavior.

Price Analysis

This method involves the breakdown of a price to a unifying figure.

Financial Statement Analysis

This is the most important method especially in a financial organization.

This method involves the analysis of the accounts and the economic prospects of a firm.

Financial Analysis is the process of assessing a company’s financial position by analyzing its stability, viability, and profitability.

One of the primary objectives of financial analysis is to recognize changes in financial trends, help track the progress made by an organization, and identify a relationship to draw a logical conclusion on the company’s performance.

Financial statement analysis helps measure the results of a firm’s policies and operations in monetary terms.

In assessing the company’s overall financial condition, the income statement and the balance sheet are important reports, as the income statement captures the company’s operating performance and the balance sheet shows its net worth.

Financial statement analysis could be assessed using the following key measures, which are important to assess the current financial position and performance.

These are descriptive and analytical measures of financial position and performance. That includes current assets, current liabilities, total assets, stockholders equity, total revenues, and total expenses.

What are Financial Statements?

Financial statements are formal records of the financial activities and position of a business, person, or other existing things.

Important financial data are always presented in a structured manner and shape that can be easily understood. 

The financial statements that are accompanied by a management discussion and analysis include four basic financial statements, and they are;

Cash flow statement

This reports a company’s cash flow activities, particularly its operating, investing and financing activities over a stated period.

In other words, this is the statement that Involves the flow of money from inside and outside the organization through business transactions or investment purposes.

Cash flow shows the inflow and the outflow of the cash flow in and out of Business during the financial period. This gives the investors an idea if the company has enough funds to pay for its expenses and purchases.

There are three major headings in the cash flow analysis, namely, Operating, Investing, and Financing.

These three operations in cash flow give the Business an overview of the Business in general.

Balance sheet 

This is also known as the statement of financial position, reports on a company’s assets, liabilities, and owners at a given point in time.

The financial statement explains everything the company or the owners owned then when the data or information was collected and recorded. The balance sheet shows the company’s financial position and provides detailed investments of the company’s asset investments.

The balance sheet also contains the company’s debt and equity levels.

This capital mix helps investors and creditors understand the position and the company’s performance.

Income statement

This is also known as profit and loss report(P and L report), or statement of comprehensive income, or statement of revenue and expense reports on a company’s income, expenses, and profits over a stated period.

A profit and loss statement provides information on the dealings of the organization.

These include sales and the various expenses the company experienced during the stated period. Since the balance sheet is a snapshot of the company’s assets, liabilities, equity, and debt, it does not show what happened in the period that caused the company to get to the position where it is now.

Therefore, profit figures on the income statement are important to the investors.

Income analysis contains sales, expenses, losses, and profit. Using these statements can help investors evaluate the company’s past performance and determine the future cash flows, which may help the investor consider the investment or withdraw from it.

Statement of changes in equity

 Also known as a statement of equity and statement of retained earnings, this gives reports on the changes in equity of the company over a stated period.

This is primarily important to the equity shareholders because it shows the changes in the components like retained earnings during the period. The difference between equity and debt shows the company’s net worth.

A company with a steady increase in retained earnings is sustainable instead of increasing its shareholder base.

These statements may be complicated for large corporations and may include a large set of footnotes to the financial statements and management analysis. The notes typically describe each item on the balance sheet, income statement and cash flow statement in further detail. Notes to financial statements are considered an integral part of the financial statements.

Importance of Financial Statements

  •  To give necessary information on how an organization operates financially and how cash is disbursed (inflow and outflow of cash).
  • To analyze whether an organization is stable or profitable enough for a financial investment.
  • To set monetary rules, basically rules on how cash is used in the organization,build future plans for the organization and provide solutions to financial problems in the organization.
  • To compare previous result of previous financial assessment with the present result of present financial assessment.

Financial statements basically reflects the financial performance of an organization, and helps you make better business decisions and provides questions and answers to an organization’s financial problems.

Analysis of how financial statements helps in the performance of an organization

For Shareholders 

Shareholders are the business owners but do not take part in making decisions and day-to-day activities. However, these results are shared with the shareholders at the organization’s annual meeting held for the board members and shareholders. 

Financial statements are the most important source of information for current and prospective customers. They also need to understand the dividend payout ratio and foretell the future dividends.

For the Organization

Debt can cripple the progress of any company, no matter which sector the company belongs to. Ratios like debt to equity, interest coverage ratio, debt service charge help the management take important decisions related to debt.

If the organization wishes to borrow any money, it can look at the current liabilities by using the financial statements. Business loans and credit cards are liabilities that the company must consider before applying for other loans.

When it comes to tracking records, it helps the company get accurate and regular information, which helps in the swift decision-making to avoid the organization running at a loss.

For the Management 

The complications and the size of the Business make it necessary for the management to have up-to-date, accurate and detailed data of the Business and the financial position.

The financial position helps the management understand the company’s performance in comparison to the other businesses and the sector.

Providing management with accurate information enables them to form appropriate policies for the companies and take correct decisions.

These analyses rank the performance of the management, and it will help justify the work of the management and every party involved in the Business.

For the Government

This is another importance of the financial statements that the government uses for taxation purposes.

The government uses the business performance of these companies in various sectors to assess the economy’s performance, thereby using these performances to grow the country’s economy when necessary.

For the Employees

Some companies present different financial statements for their employees. Employees need business information for mainly two reasons; their current wage and future salary appraisals.

They will be interested in knowing the current condition and the future earnings of the company to know what steps they need to take in case the company is going into bankruptcy. 

For Creditors and Lenders

Creditors and Lenders are most concerned about the company’s debt position.

Suppose the debt level is higher than the other companies in the same industry. In that case, it means that the company is over-leveraged. Analyzing these statements will help them decide if they want to continue and determine how the future turns out for themselves and the company involved.

In conclusion

In any financial organization, it is important to know how financial statements help in the organization’s performance to understand how to analyze the organization’s financial statements critically.

This requires identifying the organization’s strategy, profits, risks, how valuable the organization is, what services it offers, and how independent its finances are (if they are always taking loans and if they are running at a loss).

Additional information added to the end of financial statements can help explain specific items in the statements and provide a more comprehensive assessment of a company’s financial condition known as notes.

Also, there are important things to note when accessing financial statements, and they include; contingent liabilities, debt, ongoing concern criteria, also known as contextual information, which explains the financial numbers.

Noting these things down clarifies individual statements and explains the accounting methods used to prepare the statement.

 

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