The Usefulness Of Financial Statements In Assessing The Performance Of Companies And In Guiding Investment Decisions

THE USEFULNESS OF FINANCIAL STATEMENTS IN ASSESSING THE PERFORMANCE OF COMPANIES AND IN GUIDING INVESTMENT DECISIONS

Many authors have written books on financial statements and financial accounts of companies on a general basis but very few have attempted to give this subject matter, the wide coverage it needs.  However, in spite of this obvious handicap, efforts were made to relate the scanty available literature to be subject mater of this study.

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The availability of financial statement of companies and financial capital is a pre-requisite for the rapid development and transformation of any nations economy and the development of accounting information.  Since the provision and efficient management of this scarce resources is best facilitated by the existence and appropriate functioning of financial institutions in the economy, it follows that final accounts of companies being properly prepared by accountants have a vital role to play in the development and upkeep of records in any organization in the economy.

The first view of the financial accounting statement system was formally articulated in 1919 by Werner Sombert in Dev Modere Kapitalismus.  He wrote “capitalism, without double entry book-keeping is simply inconceivable, they hold together as firm and matter.”

In the mid 1920s, Max Weber expanded this view saying “A rational capitalistic establishment is one with capital accounting, this is an establishment which determines its income yielding power by calculation according to the methods of modern book-keeping and the striking of a balance sheet.”

Somebert and his follower believed that double entry book-keeping was essential for the separation of the business from its owners the entity view.  He argued that certain important management objectives clarity of contractual relationships systematic recording of financial business events could be achieved only by use of a modern accounting system that is properly monitored.

In the early centuries, the big corporations had many critics who called for improved reporting.  Accountants also advocated better disclosure of financial records and emphasized the importance of an independent audit.

According to Journal of Accountancy, which applauded the action, the decision by equitable to disclose was an effort to restore public confidence and to avoid restrictive legislation.  There was variety of reasons for corporations to disclose financial information, but the common impression today is that financial reporting in the late 19th and early 20th centuries was at best rudimentary and at worst non-existent.  These impressions of accounting are due to many factors, one of which is the work of William Z. Riphley, a Howard Professor who was a critic of early disclosure practices his book, main street and wall street was first published in 1997 and was reprinted by Scholary Books Co in 1999.  One of the chapters is based on an article “stop, look, listen.  The shareholders right to adequate information,” which appear in the September 1995 issue of a letterary magazine, the Atlantic monthly.  Its interesting to and note that George O. May, who was at this time the Senior Partner of price water house, quickly responded to Riphleys Criticisms of financial reporting by writing a letter that was printed in the August 30, 2001, editor of the New York times.  While many agreed “that stock holders are entitled to receive reasonably full information regarding the affairs of a company in which they are interested,” he also said that article by Riphley was “unfair both in detail and in the larger.”

Black Homer A, et al pointed out in their work that financial statement should aid decision making at all levels of management in addition to meeting the needs of the outsiders.  A good financial statement should always provide timely, relevant, quantifiable, veritable, unbiased and reliable information  which should help the management of a business organization in decision making and also the external users in making economic or financial decisions.

According to them, there are two categories of users of accounting information.  They are:

The internal users:  which is the management of a business enterprises; and the external users:  which are as follows:  the shareholders or owners, creditors, investors, customers, employees and trade unions, government and credit reporting agencies.

In preparing the financial statements, information about inventories are needed.  Other documents provided evidence on the amount of personal expenses to be deducted from salaries and pocket expenses” as well as to the appraised value of land and buildings.  Reference to these documents were made in notes that appeared directly on the financial statements.  The amount deducted from wages and salaries, and pocket expenditure are authorized.

In Nigeria, the state of the economy does not yet warrant much meaningful investment.  The industrial infrastructure are either lacking completely or inadequate.  In spite of opportunities and high profit prospects, private enterprise is often inhibited by basic infrastructural problems, rural areas which account for a disproportionate fraction of the macro-economy, are often completely inaccessible to industrial activities for lack of roads, power etc.

Central purpose, but this is erroneous because we know that it is possible to run a business without profit for a time. It is not possible for it to survive for one day without customers.  This means that everyone in business must realize that the business begins and ends and high profits or losses are earned with the customers.

The serious financing problems faced by investors in Nigeria is another case in point.  It is no longer a news nowadays that business people go through a real difficulty time in getting loans which unfortunately are often short term.

The stringent regulations on granting of loans makes it difficult.  It is not impossible for investors to obtain loans since they can hardly meet such requirements.  More often than not, they have to resort to petty borrowing which does not only subject them and their business to unexpected financial hazards but also makes explanation very difficult with the result that the industrial scene in Nigeria is characterized by a proliferation of small scale and petty business.

On this view, several companies were in this happy situation of being able to plan their path of growth and profitability scientifically.  Unfortunately, the recession meant several things to several companies.

In order to analyze financial statements, users must have a basic understanding of the concepts and principles underlying their preparation without such an understanding, users will not recognize the limits of financial statements.

Accountants use several terms when describing the underlying considerations on which financial statements are prepared.  Some of these terms are assumptions, concepts, postulates, or principles.  It is not necessary to distinguish between an assumption, concept, postulate, or principle, however, in order to understand the basic ideas that underlie the preparation of financial statements.

The ideas that underlie the preparation of financial statements have developed over several hundred years and continue to develop today to meet the needs of a changing society.  A review of these basic concepts should help the reader to understand and therefore, better analyze the statements.

 

2.1     BASIC CONCEPTS:

(a)     Business Entity:

Accounts are kept for business entities as distinct from the persons who subscribe capital to run these entities. In recording facts in the accounts, the important question is; how do they affect the business?  And how do they affect the persons who own, operate, or otherwise are associated with the business?  When the owner takes cash out of his business, for example, the accounting records show that the business has less cash than hitherto, even though the real effect of this event on the owner himself may have been immaterial, he has taken cash from his business file. Even though it remains his cash there must be a way of showing the difference.

And also it can be defined as the data gathered in an accounting system are assumed to relate to a specific business unit or entity.  The business entity concept assumes that each business has an existence separate from its owners, creditors, employees, customers, other interpreted parties, and from other businesses.

(b)     Going-Concern Or Continuity

Unless strong evidence exists to the contrary the accountant assumes that the business entity will continue operations into the indefinite future. This assumption is referred to as the continuity or going-concern assumption.  Assuming that the entity will continue indefinitely allows the accountant to value assets at cost on the balance sheet since they are to be used rather than sold.  Market values of these assets would only be relevant if they were for sale.

By making the going-concern assumption, the view that the entity will go bankrupt or be liquidated is removed.  If in reality, a particular entity is threatened with bankruptcy or liquidation then the going concern assumption should be dropped.  In this case, the render of the financial statements is interpreted in the liquidation values and not in the values that can be used when making the assumption that the business will continue indefinitely.  If the going concern assumption was not used for a particular set of financial statements, because of the threat of liquidation, or bankruptcy, then the statements were prepared with the view that the entity would be liquidated or that it is quitting concern.  In this case, conventional financial statements figures would be misleading if it were not for the going-concern assumption.  For instance, prepaid insurance is computed by spreading the cost of the insurance over the period of time of the policy.  If the entity is liquidated, then only the cancellation value of the policy would be meaningful.

(c)      Monetary Unit:

In accounting, all records are made only of those facts that can be expressed in monetary terms.  The advantage of expressing facts in monetary terms is that money provides a common denominator by means of which heterogeneous facts about a business can be expressed in terms of number that can be added ad subtracted.

Accounting, for instance, does not record the state of the General Managers’ health, it does not record the fact that there exists relationship problems among the rank and file of management personnel, it does not report that the industrial relation is not stable and it does not reveal that a competitor has placed a better product on the market.  Accounting, therefore, does not give a complete account of the happenings in a business as an accurate picture of the condition of the business.

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