IGNOU : M.COM : MCO 5 : UNIT 4 : Q - 1. What are the financial statements? How far are they useful for decision-making purposes?

Ans. USES OF FINANCIAL STATEMENTS

The financial statements are useful in many ways in the process of decision making. They are the basis of decision making for its users, namely management, investors, creditors, government authorities, etc. Let us now discuss the usefulness of financial statements.

1) Economic Decision-making

Sound economic decisions (of external users) require assessment of impact of current business activities and development on the earning power of the company. Information about economic resources and obligations of a business enterprise is needed to form judgement about the ability of the enterprise to survive, to adopt, to grow, to prosper amid changing economic conditions. In this process, the financial statements provide information that is important in evaluating the strength and weaknesses of the enterprise and its ability to meet it’s commitments.

2) Investors Decisions

 Adequate disclosure in the financial statements in expected to have favourable effect on security process of the company. An informed investor is always in a position to take appropriate and timely decision on investment or disinvestment. Financial statements and annual reports provide necessary information regarding profitability, dividend policy, net worth, intrinsic value of shares. Earnings per share (EPS) to assess future prospects to substantiate their investment decisions. The group is not only interested in present health of the enterprise but the future fitness as well. Bankers & financial institutions and foreign institutional investors are always worried about the future solvency of the invested firms.

3) Employees’ Decisions

Employees‘ decisions are usually based on perceptions of a company’s economic status acquired through financial statements. Employees and their trade unions use the financial statements to assess risk and growth potential of a company, which helps settle industrial disputes, avert lockout & strike or likewise situation arise form demand for wage hike, bonus, higher compensation, more fringe benefits, better working conditions and so on. Labour unions and individual employees use financial statements as the basis for collective bargaining and settlement. Tis develops sense of belongingness among the workers for they know that their interest is not being jeopardised.

4) Creditors and Financiers

Short-term creditors make use of the financial statements mainly to ascertain the ability of the firm to pay its current liabilities one time and the value of stock and other asset which can be accepted as security against credits granted. Long-term creditors and financiers are more concerned about the firm’s ability to repay the principal amount as and when due. From the financial data provided by the periodic statements, it is possible to make projections about the generation of funds and cash flows, which may assure the safety of investment in debentures and loans.

5) Customers’ Public and Competitiors’ Decisions .

Customers and the public in general may use financial statements to predict and forecast future prospect of the company. This information may be important in estimating the value of warranty or in predicting the availability of supporting services or continuing supplies of goods over an extended period of time. Likewise, competitors may analyse financial statements (from competition point of view) to judge the ability of competitor to withstand competition and it’s absorbing capacity.

6) Managerial Decisions

Published account and reports forming part of financial statements may have economic effects through it’s impact on the behaviour of the managers of corporate enterprises. Financial statements provide necessary information base for taking all managerial decisions. In the absence of accounting information neither the objectives of the enterprise can be laid down nor measurement and evaluation of performance is possible nor corrective measures can be taken. Managerial tools such as production budget, sales budget, cash budget, capital budget, and master budget etc. are all the offspring of financial statements. Similarly, wage policy, price policy, credit policy, recruitment policy and other policy matters are decided after careful analysis of financial statements.

7) Government and it’s Agencies

Government Agencies include taxation authorities and regulatory bodies such as Ministry of Trade & Commerce, Company Law Board, Registrar of Joint Stock Companies, Securities Exchange Board of India (SEBI). These agencies require information for policy decisions purposes. It may be a fiscal policy of Central Board of Direct Taxes (CBDT) or a regulatory policy of company law board and so on, they all require financial statements for policy formulation purposes.

8) Others

The financial statements are also useful to stock exchange, brokers, underwriters, press and the public in general. Though Their interest and goals being altogether different in nature, yet they require accounting information in the form of financial statements to serve their own ends. For example researchers may provide some startling facts and findings which may be used by Government to set its economic policy, by regulatory agencies to take regulatory measures and by management to review its own policies and by the public (NGO’s) for social reporting purposes. Social reporting aims at measuring adverse and beneficial effects of an enterprise activities both on the company and those affected by the firm; it measures social costs and the related benefits thereof.