HOW TO financial statement useful to different user and describe the limitations of financial statement? financial statement analysis
Ok lets discuss this in very simple word where a layman also can understand this.
- The Most important report
- Limitations of financial statement
1st thing 1st:-
1. What is statement of financial ? purpose of financial statements?
A bunch of report by which we can know or found the exact position of the company.Financial statement includes presentation and disclosure of financial position . The main objective of financial statement is to reflect true and fair
information to the users.
A Complete types of financial statements include:
(i) A balance Sheet at the end if the period
(ii) Statement of Profit and Loss Statement for the period
(iii) Statement of changes in Equity
(iv) Statement of Cash Flows
(v) Significant Accounting Policies and other explanatory notes as a separate statement
(vi) Comparative information with the previous periods
(vii) A balance sheet at the beginning of the earliest comparative period if the company applies an accounting
policy retrospectively or makes retrospective statement.
2. Now the actual question is how different users will get benefit from this statements ? importance of financial statement to users?
1. Financial statement is made according to the section of 133 of Company Act 2013 i.e IND AS(for india)/
International Financial Reporting Standards (IFRS) for this countries
IFRS adopted countries:-
Australia
Austria
Bulgaria
Canada
Chile
China
Finland
Hong Kong SAR
Indonesia
Israel
Korea (South)
Latvia
Lithuania
Macao SAR
Malaysia
Mongolia
Myanmar
New Zealand
Poland
Rwanda
Saudi Arabia
Slovenia
Sweden
Chinese Taipei
Turkey
Uganda.
and in this standard there is a term called going concern basis i.e the entity will last for fore sable future. & this has to be said in financial statements that is the books actually made according to this term or not.
- Why this is important?
- Usefulness of financial statements ?
- what should investors look for in financial statements?
let x ltd going to liquidate that means they don't want to continue its business. now its main moto is to sale its assets and from this money they will repay all the debt and rest they will take or shareholders will take. now in this time the valuation of the fixed assets will be calculated by resale value method. let a fixed assets purchased 1 year ago with $1 million having 15% deprecation. so if it is going concern we valued it $0.85 million, where we book a expenses of $ 0.15 million. but in resale value method we can only show resale value, due to very less buyer or less demand it may get value $ 0.50 million, where in this time we book a expenses of $ 0.50 million which reduce not only assets value but also profit by $0.35 million.
users point of view, users of financial statements
Bank :- should not give loan it may be bad debt
investor :- are you kidding
shareholder :- most of the situation they loss.
importance of financial statements
to stakeholders :- yes you have to get other party
to stakeholders :- yes you have to get other party
similer industry :- conversion start for acquisition, amalgamation
debtor :- holy shit. we have to repay their debt as soon as possible otherwise thy can sue us.
creditor (internal users of financial statement) :- we won. we will get our money soon.
2. sales
if it is declining try to see other competitor sale. relate with them. find a trend.
now how can you understand less sale is for?
go to balance sheet a check current assets if inventory are more
1.Raw material = very much stock= they know sale will be less
or purchased for future, may be price increase.
2. WIP and finished stock= more than 10% of sale = hmm thats bad
you can also see stock turnover ratio i.e (total sale/ avarage stock) =if less than 8 ( hay management where are you)
example :- automobile industry ( 6.2) during covid-19.
users point of view, users of financial statements
Bank :- should not give loan it may be bad debt
investor :- are you kidding again. losing interest
shareholder :- they loss.
importance of financial statements
to stakeholders :- yes you have to get other party, cut off employee, close showroom,
similer industry :- conversion start for acquisition, amalgamation or make production high to corner it badly
advertisement company :- get more ad request for both company (money ,money).
debtor :- we are in slightly good position. cause they has money but they can't sale . now if they ask us to give money we can postponed cause their condition is not so good. they definitely don't want more person to loss faith. but day by day debtor will be less due to less sale . sometime debtor can also insist to increase credit period and less price. This is the very bad time for any company. almost 90% company in the world use to suffer this situation. may be companies need to give its product in brake even or in loss to be in the market.
1 thing we are taught is very wrong that:-
selling price = (total cost+ profit)
No this is a wrong equation,
In the world most of the product belongs to perfect competition i.e many seller and many buyer, here price is decided by market.
so the real equation is
(selling price- total cost) = profit/loss.
importance of financial statements to creditors :- in this situation where sales are very down worth,creditor will started panic due to uncertainty of their money to get. thay started more frequent reminder to repay their debt.& debit their profit loss account with provision for baddebt.
to understand:-
3. ratios
- current ratio =(current assets/current liabilities)
the ideal ratio is 2:1. it means do you have enough liquidate assets to repay debt to your creditor & met up working capital .
Now if it is less than 2
so may be you have to take loan to met up working capital cause after paying creditor you will be not have so money to operate in next year.
& then you will take loan then you have to pay interest which will reduce profit.
Now if it is more than 2
yes you have enough money to met up liabilities + working capital.
Now if it is more than 3
hay you need to invest this money to expand your business or invest somewhere for a good return why you person make this money ideal,
- Debt-to-Equity Ratio
The debt-to-equity ratio, is a quantification of a firm’s financial leverage estimated by dividing the total liabilities by stockholders’ equity. This ratio indicates the proportion of equity and debt used by the company to finance its assets.
The formula used to compute this ratio is
Total Liabilities / Shareholders Equity
- Quick Ratio
The quick ratio, also referred as the “acid test ratio” or the “quick assets ratio”, this ratio is a gauge of the short term liquidity of a firm. The quick ratio is helpful in measuring a company’s short term debts with its most liquid assets.
The formula used for computing quick ratio is:
(Current Assets – Inventories)/ Current Liabilities
A higher quick ratio indicates the better position of a company.
- Return on Equity (ROE)
The return on equity is the amount of net income returned as a percentage of shareholders equity. Moreover, the return on equity estimates the profitability of a corporation by revealing the amount of profit generated by a company with the money invested by the shareholders. Also, the return on equity ratio is expressed as a percentage and is computed as:
Net Income/Shareholder's Equity
The return on equity ratio is also referred as “return on net worth” (RONW).
- Net Profit Margin
The net profit margin is a number which indicates the efficiency of a company at its cost control. A higher net profit margin shows more efficiency of the company at converting its revenue into actual profit. This ratio is a good way of making comparisons between companies in the same industry, for such companies are often subject to similar business conditions.
The formula for computing the Net Profit Margin is:
Net Profit / Net Sales
4.Advertise exp is more than R&D where product need update or in initial stage
users point of view, users of financial statements
Bank :- may give loan cause now a days ads are goods strategy
investor :- most of the don't person show interest,
shareholder :- initially they grab all but day by day it will decrease due to less popular. like Nokia.
stakeholder :- very slowly cut out employee, less salaries
similer industry :- conversion start for acquisition, amalgamation or make production high to corner it badly
advertisement company :- get more ad request from company (money ,money).
in profit loss account a huge interest of loan means less profit.
also you can see debt equity ratio
users point of view, users of financial statements
Bank :-if credit score is good loan can be given.but getting loan will not be easy where you are already in debt
investor :- can show interest if future is good .
shareholder :- due to less profit for some time it became down
stakeholder :- very slowly cut out employee, less salaries
similer industry :- conversion start for acquisition, amalgamation or make production high to corner it badly
advertisement company :- get more ad request from company (money ,money).
6.huge interest of loan , loss, huge provision for baddebt.
users point of view, users of financial statements
Bank :-no loan
investor :- may not show interest even future is good .
shareholder :- fluctuation in share price .down slope
stakeholder :- very slowly cut out employee, less salaries, no salaries
similer industry :- conversion start for acquisition, amalgamation
advertisement company :- may get more ad request from company
Tax authorities :- notice for scrutiny
7. Statement of changes in Equity
a bunch of activity during the year bonus, dividend, right issue and yes don't think that getting dividend means this company should be in good position they can even give you in loss making position. & most important if you see that promoters are selling their share 90% time this company lost. as an example see yes bank.
8.cash flow:-
all inflow outflow of liquid cash where any one can understand in how all money are distributed among operating activity, manufacturing activity, overhead activity etc.
the most important report :-
cost audit report.
- Limitations of financial statement:-
above we discuss about what is helpful or advantage of financial statement, but in our mind we all know nothing is 100% perfect. that means it also has some limitation. lets find:-
- Limitations of financial statement:-
1. Based on historical costs:
yes,Financial statement never gives you a real time value of fixed assets until its not a going concern. now what is going concern? now I think you understand.
2. Inflationary
suppose in your country president gone mad and order the mint to print money continuously like zimbabwe (jokes a part). so it causes inflation (when price of every thing goes up).then the company having some fixed assets value became 1.2 times. so as per the financial statement it will not show true value.
3. Judgment in respect of various accounting policies:
financial statements are drawn by maintaining accounting standard rules. Now in the world there are many accounting standard, followed by different different company, like US GAAP, IFRS(accepted by 166 countries), IAS, IND AS,Indian GAAP etc.
4. Intangible assets not recorded:
sometimes,We don't show many intangible assets under intangible fixed assets head. Instead, we spend money to create that and debit as an expenses in p/l or statement of total comprehensive income which make the profit less.
5. Interim reports :-
interim reports are not final reports. so any one can get mislead by this report. like 1st quarter says x company get a huge contract. by seeing that many person purchased their share. but during the year it don't get any contract so share price become low.
6. Not always comparable across companies:
If a company tries to compare the reports of its financial with different companies, their financial statements may be not comparable, cause different companies use different accounting practices.
7. False figures:
The management of a company may manipulate the reports. This situation arises when there is undue pressure to make report good to attract people to invest, to increase sale figure, to decrease doubt, to get bank loan etc.
8.Lack of non-financial factors:
The financial statements only gives you to take into consideration financial factors but they don't reveal non-financial factor, such as the environmental attentiveness of a company’s operations, or how well it works with the local community.
IFRS vs Indian GAAP | Important Differences Between IFRS and Indian GAAP
0 comments:
Post a Comment