Following is your guide to understanding their types and various aspects.
Yes, you heard that right. The reason is that the issuer of the financial statement does not always necessarily want to convey a clear and direct picture to the analyst about the company’s financial condition. Instead, it wants to portray the stocks and the company’s Profitability in a brighter picture.
Experts have always suggested that a reader of financial statements takes everything with a pinch of salt and does not trust all that meets the eye.
Having too much pessimism about everything can rightly be seen as not an excellent way to go about life. However, when it comes to analyzing financial statements, it is your responsibility to be crude about the issues related to the financial statements because they have prepared them not for you but to depict a good image of the company. So, it is just like a basketball match in which you temporarily consider someone your opponent so that you can understand their strategies better.
You might assume that as a skeptical analyst, you are playing a negative role here as the company tries to win the Goodwill of the investors. This is certainly not the case, as it has been stated that it is like a match in which the teams are there to fight on the ground, and later, you can have a drink together. It is the objectiveness of the litigators to try to win the case against each other, whether there is any merit in the case of the litigants or not. A better financial analyst maintains objectivity and does not get overwhelmed by the moralistic tone in which financial statement writers are typically portrayed.
Companies in North America usually follow the rules known as Generally Accepted Accounting Principles, whereas international companies go by the International Financial Reporting Standards IFRS
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It is usually considered the most important financial statement. At a given time, it also portrays revenues, expenses, profits, income, and earnings per share, which are companies’ operating results. The period of statements is over a quarter of a year or months to a year. Such a statement aims to convey the company’s Profitability and establish a business’s financial results. Understanding the revenues of the company is highly affected by it.
Similarly, you will be able to know how well a company manages its assets and how likely you are to make profits if you associate with this company.
Another kind of important information that you get from financial statements is the information related to kinds of revenues, which can be differentiated as:
The value of assets is subjective, and balance sheets are prone to sudden and arbitrary revisions. One dramatic example is from July 27, 2001. GDS Uniphase, a manufacturer of telecommunication components, wrote off its value by a massive 44.8 billion dollars. This was the biggest write-off in corporate history.
This event did not take place in one day. If you relied only on financial statements, you could have thought that it was a sudden event, which it was not. It is another reason why you cannot rely solely on financial statements.
A few months prior to the write-off, the company had advised the investors that they should expect a big write-off because of the declining business prospects. This decline in value was not unprecedented; another company took a 12.3-billion-dollar write-off, and several major companies in the area related to internet software and optical fibre followed suit.
Both old and new economic companies are vulnerable to the loss of stated asset value. Therefore, users of financial statements should not assume that the balance sheet figure is an accurate representation of the current economic worth of the assets it represents.
An accountant may be looking for the numbers related to equity in the financial statements. The economist calculates equity as the future cash flow accruing to the owners.
This is another dramatic phenomenon that differences in the definition of equity between an accountant and an economist create. In an economist’s understanding, equity of less than zero means that the company is going to be bankrupt. Now, it should go into liquidation to pay off the liabilities to the creditors.
Companies can increase revenues and earnings in the current period. However, the increase in credit losses will not appear until a later period.
Suppose a manufacturer institutes a discount to encourage its wholesalers and dealers to place orders earlier than they would otherwise. This way, the revenue in the financial statement will be greater for this particular quarter than it would typically be without the discount.
In this way, the user of the financial statement will face disappointment. For instance, if he considers the revenues depicted in the financial statement an indicator of future profits, he’s in the wrong.
The world of numbers and finances is a sea of paperwork. Getting lost in this influx of information is not improbable, and so one needs to be well-prepared and well-equipped. The writing was to give you some understanding of the perspective of the issue and the problems that you should be careful about, or if not, the issues that you must study to be adept at reading between the numbers.
