Financial Statement Analysis

Abstract

Companies, investors, and managers normally rely heavily on the accounting data projected by company’s financial statements in order to improve their investment and management opportunity. Financial statements present company’s revenue and expending base. It incorporates income, cash flow, assets, and liabilities statements that can potentially influence a manager’s decision making process. However, the manner in which financial statement analysis is done does not project employees’ skills and competency among others can mislead manager’s decision making process. This essay discusses advantages and disadvantages of financial statement analysis in influencing the decision making process of a manager.
Keywords: financial statement analysis, manager

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Introduction

As defined by Franco, Kothari & Verdi (2009), financial statement analysis entails the process of examining organization’s financial sector and returns position with a view of acquiring additional information on its activities. Analyzing organization’s financial statement provides useful information essential for investor, creditors, executives, and more so managers. The above outlined users must potentially analyze business information through financial statement analysis in order to make profitable or good business decisions.

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Franco, Kothari & Verdi (2009) note the existence of various methods that are used in performing financial statement analysis. Among these methods are horizontal and vertical analyses. According to them, horizontal financial statement analysis involves comparing of specific items such as account payable over a given accounting period. This may be months within firm’s fiscal year. On the other hand, vertical analysis involves comparing each of firm’s income statement items such as operating expenses with incurred sales or total assets over a given accounting period. By engaging in both horizontal and vertical financial analysis methods, a firm is able to project its income statement and balance sheet from which it can determine whether it is conservative or excessive in its spending for certain items.

Therefore, the analysis of financial statements provides to firm’s stakeholders with up-to-date information. The process is thus essential for the prosperity of a business. This is based on the fact that financial statement analysis has several advantages and disadvantages, which can either positively or negatively, influence business decision offered by a firm’s manager.

As pointed out by Franco, Kothari & Verdi (2009), understanding and analyzing the financial statement of a given firm enables a manager to ensure that the organization follows the outlined accounting standards. This would help him/her in obtaining accurate income statement of the firm by projecting its financial performance over a given accounting period. According to these authors, income statement normally presents a firm’s way of balancing its expenses and revenue activities either through non-operating or operating practices. Additionally, the income statement provides either organization’s loss or profit over a given period of time.

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These projections present a manager with adequate information flow in knowing where the firm’s profit or loss arises based on its income and expenditure. Such information is helpful in ensuring that the manager is able to make appropriate business decision.
On the other hand, Franco, Kothari & Verdi (2009) point out that analyzing financial statement presents a manager with a balance sheet where he or she is able to understand the nature and impact of firms’ liabilities and assets at the end of a given accounting period. Projecting the firm’s assets base, how it sustains or pays for its own assets or liabilities it owes, and the financial base of the firms after settling all the incurred liabilities is very essential. This enables a manager to decide either to contract new staff members or engage in management structure that does not make the firm to be involved in venturing into activities that are beyond its asset base. More so, it allows a manager to settle out firm’s liabilities before venturing into other activities that in the end would make the firm to be bankrupt.

Irrespective of such advantages, financial statements analysis also presents some challenges to those in decision making positions. While it can help in pointing out bargains in the market through ratio analysis, it ignores essential employees’ productivity and skills. According to Jesswein (2011), financial statement analysis unlike management decision analysis is unable to provide the manager with ideas of evaluation skills needed to evaluate the organization’s employees. In other words, financial statement does not reflect on employee’s performance at work. In turn, a manager who is unable to know the real value of assets (employees’ skills) may make unreliable decisions such as delegating jobs to employees who cannot effectively handle them.

Additionally, financial statement only projects firm’s historical costs, which do not give a manager timely report on the current business situation. For instance, a balance sheet provides historical firm’s costs that are irrelevant as they do not give fair ideas on firm’s current asset and liability position (Jesswein, 2011). Additionally, financial statement analysis, especially income statement is based on accrual basis, which can be considered as fictional rather than the required financial report. This fictitious nature of such a financial report can present a manager with false information on company’s cash flow or income base. Based on this, a manager may hire highly paid employees or engage in employee’s compensation and benefits programs that may render the firm into insolvency.

Moreover, state to state or company to company variation in names and terminologies used when analyzing financial statement can create confusion in comparing companies’ financial statements. This in turn, would present a manager with no real picture on other influential organization’s financial obligations and entitlement of which he or she wishes to emulate. As pointed out by Jesswein (2011), most companies normally prepare their financial statements according to the standards that go beyond the stipulated international accounting standards. This breach on such standards makes it difficult not only for investors to accurately assess their company’s economic status, but also for managers who are presented with non-factual company’s financial base. By this, a manager can be tempted to emulate the management structure of prominent firms that shows huge net profit on their financial statement, thereby designing the same of which can either be ineffective or inconsequential.

Conclusion

In conclusion, financial statement analysis can essentially allow a manager to inquire information concerning the firm’s income, cash flow, asset base, and liabilities. However, it does not reflect on employee’s skills and competence. Therefore, managers should not depend only on the financial statements analysis to inform their restructuring or redesigning of management portfolio as it present fictitious picture, which eventually can mislead their decision making process.