Investors – cash flow statement I think would be the most important to an investor. The reason is that this statement shows useful information from operations, investing and financing activities. The three activities are very important because these explain where the cash is coming from and where it’s going out, so that the investor can see how far the business can on its reported cash levels.
Lenders – balance sheet would be the best choice for lender. Variety of ratios, such as debt-equity or days receivables can be computed form this document. These ratios are important for lenders when evaluating borrower’s financial position.
Employees – most likely balance sheet would be chosen because it’s easy to understand and some basic ratios such as ROE can be computed in order to get at least a basic idea how the stands at certain moment in time.
Suppliers – balance sheet because supplier will be most concerned with days payable and cash levels in the business. Balance sheet can provide this information and it’s widely available to everyone.
Customers – income statement because it shows the top line (revenues) and at the end we have the bottom line (net income). Many customers will be just happy to see this information in order to have a better understanding on how the business is performing.
Government – income statement again, because it includes tax information as well as other overheads which might be important to the government. If the business is generating too much income too easily, the government could step in with some additional tax rules or could impose some additional barriers that could feed into operating expenses of the business.
Public – balance sheet would be just enough in my opinion. The numbers and headers are easy to understand where very useful ratios such as book value or debt-equity can be instantly computed.
The requirement for IFRS has grown substantially since markets became globalised over the last two decades. Investors started looking abroad for better returns and diversification. Whereas, banks started lending funds to growing markets abroad in order to tap into the trend of emerging markets.
Businesses shift vast amounts of money across borders, which also require understanding of international accounting and standards. The IFRS standards are beneficial to variety of stakeholders who can use these numbers easily to compare multinational organisations. However, not all companies issue IFRS results because of additional costs associated with computing these numbers.
Overall, the world would be much easier for all stakeholders involved if the standards were unified or if all companies were using IFRS all across the board.
Short-term liquidity risk is generally referring to company’s short-term ability to generate cash. This cash is required for day-to-day capital needs and also the current debt obligations. Whereas long-term solvency risk is also concerned with cash generation, however, the cash is needed for long-term debt re-payments, plant and equipment purchases.
The short-term liquidity can be measured with the following ratios:
- Current Ratio = Current Assets / Current Liabilities
- Quick ratio = (Cash + Receivables + Marketable Securities) / Current Liabilities
- A/R Turnover = Net Sales / Average A/R
- Days Receivables Outstanding = 365 / A/R Turnover
- Inventory Turnover = Cost of Goods Sold / Average Inventory
- Days Inventory Held = 365 / Inventory Turnover
- Accounts Payable Turnover = Inventory Purchases / Average Accounts Payable
- Days Accounts Payable Outstanding = 365 / Accounts Payable Turnover
The long-term solvency can be measured with the following ratios:
- Long-term Debt to Assets = Long-term Debt / Total Assets
- Long-term Debt to Tangible Assets = Long-term Debt / Total Tangible Assets
- Interest Coverage = Operating Income Before Taxes and Interest / Interest Expense
- Operating Cash Flow to Total Liabilities = Cash Flow from Operations / Avg Current Liabilities + Long-term Debt
Historical cost – assets are recorded on balance sheet at the purchase cost when the transaction was signed.
Money measurement – every transaction is recorded on the accounts in terms of money.
Business entity – business and its owners are two separate entities.
Dual aspect – every transaction is recorded on the books in two places, as a debit and credit. Therefore, at least two accounts are needed in order to match DR with CR.
Time interval – financial statements need to be prepared in quarterly, semi-annual or on annual basis.
The principle of revenue and expense transaction has been created to prevent mismatching that can occur when recording transaction on cash-flow basis. In a nutshell, revenues need to be matched with relevant expenses in certain period. This is known as revenue recognition which is then matched with expenses that has been incurred in order to generate that revenue. Therefore, accrual accounting is the preferred way of recording revenues, because it matches revenues with expenses as opposed to cash flow accounting.
In my opinion revenue recognition is potentially most dangerous yet easiest to implement by creative managers. For instance, excessive trade receivables recognition in order to boost EPS and cash in nice bonus. This very short-term technique can bring an organisation to its knees.
Therefore, if trade receivables (accrual accounting) grow substantially quicker than cash from operations (true cash to the business) then this could be a “red flag” demanding cautious investigation of the financial statements.
Financial reporting is important for anyone who wants to know more about an organisation, its business, historical performance and current health. Moreover, the financial reports can also be used to carefully, not always accurately, forecast future earnings, sales etc.
Variety of individuals will use financial reports: investors, lenders, government, customers, business partners, suppliers. Therefore, understanding of financial statements is paramount. However, even more important is that the financial regulations are relatively similar amongst countries an jurisdictions.
In the end financial statements are computed by humans and for that reason these numbers can be sewed in many directions, for instance contracting and bonuses. Financial analysts need to be aware of such possibilities.
In general EV metrics take into account total capital structure of an organisation (equity + debt – cash), whereas, P ratio is concerned with equity only.
When an analysis comes down to selection based on EV versus P metric, an analyst should use EV metric because it will present “truer” picture on an organisation being analysed. This will mostly become apparent when financial leverage difference is substantial between peers.
P/S is calculated from total sales (revenue) a business has generated in an accounting period, whereas, P/E is the net figure of these sales, excluding taxes and expenses. Therefore, P/E can be easily manipulated, because there’s a long way down from total sales to the earnings.
Moreover, P/E can be a negative if the company paid more expenses and taxes that it earned from sales. For these reasons, P/S is viewed as a more stable metric used to value and compare companies.