Financial Statement Analysis as an Instrument

Question: Discuss about theFinancial Statement Analysis as an Instrument. Answer Introduction An evaluation method interpreting an entitys past, current and expected performance which can be also said as future projections. The financial statements give the pictures of future projections on the basis of financial ratios and other techniques which are adopted by the users of the financial statements to ascertain the performance of the company. Users of financial statements include both internal and external stakeholders. Internal stakeholders include management, as they need to make day to day decisions in performing the operations of the company. While the external stakeholders include shareholders who are often owners of the company, while the investors for instance equity and credit investors, public in general, government and those concerned about making decisions in an entity. The financial statement analysis can also be used as an instrument to predict the probability in case of bankruptcy. After analyzing the financial statements, the analysts provide reports based on, analysis eventually certifying that the financial statements are prepared and there are no hidden defects in the statements. The analysis provides you with a predictable instrument so that you are able to make financial decisions and whether there are any debt issues or the company is under severe debt. Literature Many of the companies use financial statement analysis tools (White et al., 1997) for analyzing the statements so that users have no problem in making decisions, such tools financial statements include: Fundamental Analysis This analyzes the businesss financial statements such as assets, liabilities and earnings health and its competitors and markets. Such analysis mainly focuses on the long term economic state. Such analysis mainly includes: Economic analysis Industry analysis Company analysis Ratio Analysis Ratio analysis looks particularly at both of the factors which includes qualitative (general factors) and quantitative (substantial and physical factors) aspects of the financial statements. Attractive results can be achieved by quantitative analysis whenever they used with other techniques. Usually comparisons are made using such ratios between: companies industries a single company and its industry average different time periods for one company Ratios for analyzing the financial statements include the following: Performance Gross profit margin Price/earnings ratio Profit margin Return on assets Return on equity Earnings per share Dividend payout ratio Activity Asset turnover Average collection period Inventory turnover Financing Debt Ratio Debt / Equity ratio Liquidity warnings Current ratio Acid test ratio Cash ratio Working capital These are some of the ratios to analyze the financial statement to help the users of the financial statements to make decisions which are beneficial to them based on these ratios. DuPont Analysis DuPont analysis splits Return on Equity into three definite elements. Such an analysis assists in understanding root cause higher (lower) return when comparing with companies in identical companies. In defining financial statement analysis as an instrument helping to predict the probability in case of bankruptcy, there can also be flaws as to how the company makes an accounting treatment with regards to various financial statement assertions (Taylor and Anastasia, 2015). The management can also use loopholes in the accounting to show their financial performance and position best so as to acquire more borrowing. This raises higher incomes to the investors and owners of the company. In relation to real life examples here are some of the companies that were bankrupted due to poor financial reporting and accounting loop holes which includes: Lehman Brothers In the top 10 United States collapses Lehman Brothers has been ranked as number 01. The date of their filing bankruptcy was 09/15/08 and their assets at the time of bankruptcy totaled to USD 691 billion (Tkaczyk and reporter, 2001). A financial services firms leveraging of borrowed money caused the biggest bankruptcy in US history in 2008, and the company fizzled out of existence in a rapid decline that it enhanced the economic devastation on the ongoing crises. New emerged that executives increased their pay just before bankruptcy and accounts had been altered to hide the Banks poor financial position. This case stands as the perfect example of the culture of excess causing worldwide suffering for billions of people (WatchMojo.com, 2016). Even before the financial crises Lehman Brotherswas already in a seat of going easy with its accounting which had placed investment banker in an acute stress to guarantee its investors. It was done by usage of a practice known as Repo 105, a type of repurchase agreement (or "repo" deal) which for the time being removes securities in the balance sheet and showing it as a security sale by Lehman (Monitor and Trumbull, 2010). The main reason of such collapse is they did not reveal the significant usage of medium relating to accounting and lowering the leverage for the time being simultaneously that it showed a positive picture to investors as low leverage numbers, thus establishing deceiving portrait regarding the truth of Financial health of the entity. (Anton R valukas, Exminer) World Call The World Call has been ranked at number 3. The date of their filing bankruptcy was 07/21/02 and their assets at the time of bankruptcy totaled to USD 103.9 billion (Tkaczyk and reporter, 2001). This telecommunication corporation held the record for the biggest bankruptcy in 2002 before the Lehman brothers collapse took its unwanted title six years later. Throughout the early 2000s the company was utilizing a complex scheme of adjusting its books to hide the considerable losses. By 2003 it spot that its total assets have been fraudulently inflated by USD 11 billion (WatchMojo.com, 2016). Enron Similarly Enron has been ranked at number 6. The date of their filing bankruptcy was 12/02/01 and their assets at the time of bankruptcy totaled to USD 65.5 billion (Tkaczyk and reporter, 2001). In a space concerning a month or so this energy giant went from being one of the biggest companies in the world to bankrupt. Main instances of the scandal were the failures of accounting firm Arthur Anderson LLP which neglected to report Enrons crime and led to firms own dissolution. Enron's results for 1998, 1999, and 2000 suggest some interesting comparisons. The firm's revenues increased by $10 billion from 1998 to 1999, and by $60 billion (to $100 billion) from 1999 to 2000 (Bratton 2002). The share scale of Enrons fraudulent activity is difficult to comprehend as it allowed the business to pretend it was running on USD 100 billion in revenues through the use of loop holes and the poor financial reporting and more to conceal its massive debt. Many critics thought that for an energy company to be so reckless was particularly and those involved deserved their harsh sentences (WatchMojo.com, 2016). Conclusion After reviewing the above scenario it can be established that even though there are some loopholes in the accounting system, proper accounting tools should be applied so that the information is definitely clear. The experts should relate the above matter in relation to the frauds the companies are making by using such loopholes and making things visible clearer for the users of the financial statements. Even though financial statement analysis provides variety of information used in identifying potential problems, there are several problems which need to be addressed such as Operational information is not taken into account by the analysts who should reconsider as it may provide some general performance predictors for the future such as warranty claims, orders being backlogged and many more. Another big issue for the analysts is the comparison between companies, using ratio analysis to compare the picture of two different entities might not bring out expected results as the entity might pile up the required information differently in drawing their respective financial statements might result an incorrect outcome about an entity as opposed to other entities in the same industry. By applying appropriate measures and attention to the individual particulars, so that their effects on such particulars are well formed and analyses of financial statements are therefore adjusted. References Bratton, W. W. (May 2002). "Enron and the Dark Side of Shareholder Value" Monitor, T.C.S. and Trumbull, M. (2010) Lehman Bros. Used accounting trick amid financial crisis and earlier.Available at: https://www.csmonitor.com/USA/2010/0312/Lehman-Bros.-used-accounting-trick-amid-financial-crisis-and-earlier. Tkaczyk, C. reporter (2009)The 10 largest U.S. Bankruptcies Available at:https://archive.fortune.com/galleries/2009/fortune/0905/gallery.largest_bankruptcies.fortune/ Taylor, S.J. and Anastasia (2015) Business,Business, 14 September. Available at: https://www.cleverism.com/financial-statement-analysis-introduction WatchMojo.com (2016) Top 10 corporate scandals. Available at: https://www.youtube.com/watch?v=_QepKsfmfSo White, G.I.; Sondhi, A.C.; Fried, D. and Fried, H.D. (1997). The Analysis and Use of Financial Statetments.2nd edn. NewYork, John Wiley Sons, Inc.ISBN0-471-11186-4.