Learning Engagement, Week 7:

What are the objectives of financial statements?  

What are the limitations of financial statement analysis?

1. Discuss the need for comparative analysis and how it affects decision-making in the workplace?

Identify 3 different tools of financial statement analysis, describing each in detail with an example of the tool illustrated

1. PROFESSOR’S GUIDANCE FOR THIS WEEK’S LE:
2. Managerial Accountants develop financial statement analysis for a variety of reasons. Internally, the results of current operations are compared against benchmarks to determine if the company is on track to meet its goals. Further, we can use analysis to look beyond our company to our competitors and to the industry. Along with the Management Discussion and Analysis, supports the company’s business operations in a quantifiable way.
3. We can use these metrics as well if we are seeking to invest with a company. Different ratios can be calculated to measure areas of liquidity, profitability, and solvency—the overall health of the company. But, we need to understand how these metrics are defined and calculated. A company that uses FIFO inventory valuation can provide much different results than a company that adopted the LIFO inventory valuation. So before you produce comparative company or industry results, you need to get a good understanding of the policies and practices of that company!

by Thanyathorn Lapthitisate

Financial Statements

Question 1

Financial statements refer to a summary of the business’s accounts prepared for evaluating past performance and forecasting future performance (Smith, 2021). The objectives of financial statements include communicating quantitative and objective valuable information in making economic decisions to the users. Financial statements also meet the specific needs of conscious investors and creditors. In addition, they are used internally to offer reliable information on the business’s earnings and determine the enterprise’s ability to operate at a profit in the future. It is also used as a financial base for tax evaluations and in preparing assessments using ratios, trends, and industry comparisons.

Question 2

The limitations of financial statement analysis include:

1. It cannot substitute sound judgment; financial statement analyses are the only means to reach conclusions but cannot replace decision-making and judgment (Li, 2019). Eventually, the users will use their experience, skills, and intelligence.
2. It is based on past data; financial statement analysis only uses past financial and accounting data for evaluation. Therefore, the past may not fail to provide precise budgeting, planning, estimation, and forecasting of the future (Li, 2019).
3. It may not be comparable; financial statements usually vary from one company to another, making it impossible to compare.
4. Reliability of figures; the contents of financial statements can be easily manipulated to fit personal interests resulting in misleading conclusions.

Question 3

Comparative analysis refers to comparing products to one another to distinguish their similarities and differences. The comparative analysis provides relevant and valuable insight that influences the process of decision-making. It affects decision-making in the workplace by detailing how data or processes compare to another and elaborating their relationship. In addition, comparative analysis helps in the development of lists of differences as well as similarities that can be used in decision-making (Bhasin, 2020). It also helps the user identify external causes like environmental challenges and economic conditions that may affect business operations. The comparative analysis further affects decision-making at the workplace by considering variables that impact both sides, including both controllable and uncontrollable variables.

Question 4

Financial statement analysis tools include:

1. Comparative statements; this financial statement analysis tool deals with comparing different products of the profit and loss account and balance sheets of multiple periods (Smith, 2021).
2. Trend analysis: this financial statement analysis tool identifies the ratios of various items across different periods and then compares them. The ratios comparison over a period provides insight into whether the business is trending downward or upward. Trend analysis can be carried out concerning two or more business enterprises for the same period or another company for a different period.
3. Comparative income statement: this financial statement analysis tool provides three critical pieces of information from income statements. They include operating profit, net profit as well as gross profit.

REFERENCES

Bhasin, H. (2020). Comparative analysis and its application in business. Marketing 91.

Li, J. (2019). Research on Limitations of Financial Statement Analysis: Based on Data of Listed Companies. Proceedings of the 5th International Conference on Economics, Management, Law and Education. Wuhan, China: Atlantis Press.

Smith, A. (2021). What are the objectives of financial accounting? Corporate Finance.

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by Marwa Khudhair

Financial Statement Analysis

There are various reasons managerial accountants develop financial statement analysis. Some of the reasons for developing financial statements is to determine the true and fair view of the financial performance and position of the corporation (Lennard, 2007). As such, balance sheets indicate the corporates financial position by enlisting the liabilities and assets. Moreover, income statements show the entity’s financial performance by determining the business’s expenses and revenue.

There are various limitations to financial statements, such as It only providing interim reports, therefore not indicating the final picture of the concern. This is because the data utilized in the statements are dependent upon the personal judgment of the accountants, and the actual position of the corporation can only be determined when the corporation is liquidated or sold (Faello, 2015). The other limitation of financial statements is that it ignores the impact of non-monetary factors that have a bearing on the entity’s operating results and financial positions. Financial statements often ignore such factors, namely, commitments for purchases and sales, the reputation of the management, the cooperation of the employees, and the creditworthiness of the concern, because they cannot be measured in monetary terms (Faello, 2015).

Comparative analysis is essential for corporations since it aids in getting better insights into a problem or answering relevant questions (Bruyere et al., 2004). The comparative analysis leads to the achievement of several primary goals through comparisons of processes, data sets, or documents, such as narrowing focus and providing a frame of reference for data (Bruyere et al., 2004)

There are various financial statement analysis tools, such as vertical analysis, trend analysis, and cash flow analysis. Vertical analysis shows the factors of a business in the form of a percentage on a fixed value (Lennard, 2007). The percentages can aid the corporation in determining where the business is heading by figuring the relation between different factors and their effects on each other. Trend analysis determines the stock prices beforehand to indicate whether it is a dull market or investing will be profitable. Cash flow analysis determines the working capital and net requirements by analyzing the corporation’s net requirements and working capital. It also determines the expansion and debt in the market (Bruyere et al., 2004)

References

Bruyere, S. M., Erickson, W. A., & VanLooy, S. (2004). Comparative Study of Workplace Policy and Practices Contributing to Disability Nondiscrimination. Rehabilitation Psychology, 49(1), 28.

Faello, J. (2015). Understanding the limitations of financial ratios. Academy of accounting and financial studies journal, 19(3), 75.

Lennard, A. (2007). Stewardship and the objectives of financial statements: a comment on IASB’s preliminary views on an improved conceptual framework for financial reporting: the objective of financial reporting and qualitative characteristics of decision-useful financial reporting information. Accounting in Europe, 4(1), 51-66.

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