Last Updated 07 May 2020

Uses of Financial Statements to the Shareholders

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Financial Statements are summaries of monetary data about an enterprise. The most common annual financial statements include the balance sheet, the income statement, the statement of changes of financial position and the statement of retained earnings.

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. The shareholders are mostly concerned with the performance of the company stocks in the market, which increase our curiosity to understand why the shareholders are so keen to get information that is contained in the financial statements.

The financial statements should be understandable, relevant, reliable and comparable. They are intended to be understandable by readers who have a reasonable knowledge of business, economic activities and accounting and who are willing to study the information diligently (Kennon, 2010). Financial Statements Shoaf (2010) cites John Burr William’s basic truth that a business is only worth the profit it will generate for its owners from now until doomsday, discounted back to the present, and adjusted for inflation.

The income statement may contain information that is past but it is the reporting card for those earnings and they ultimately determine the price a potential shareholder should be willing to pay for a business or part of the business. The balance sheet and the cash flow statements are all important to the shareholder if he has to make rational decisions on his investment. According to Best (2010), the balance sheet provides the user with data about available resources as well as the claims towards those resources.

The income statement provides the user with data about the profitability of the enterprise detailing sources of revenue and the expenses which reduce profit. The statement of changes of financial position shows the sources and uses of a firm’s financial resources, demonstrating trends in the alteration of its capital structure while the statement of retained earnings reconciles the owners’ equity section of successive balance sheets, showing what has happened to generated revenue. The shareholder’s are very much interested with the overall performance of a company, since it tells them whether their investments have generated returns.

They tend to look at the overall profitability ratios as standards by which their performance is judged. The shareholders can either be existing shareholders or potential shareholders. Some shareholders seek a takeover, leading to a majority control and shareholding it is often considered to be a hostile takeover. This occurs when the company has a low market value. The value of the company in the market is assessed by the overall performance of the company which is well analyzed in the financial statements.

The other group of shareholders can be categorized as short and long-term shareholders, who are interested in increasing their wealth with minimal effort. This is either through earning dividends or trading shares in the Stock Exchange (Shoaf, 2010). Prospective shareholders make use of financial statements to assess the viability of investing in a business and thus they are provided with a basis for making investment decisions. This is due to the reason that the financial statements assess the year’s operations and can be used to forecast the company’s position in the coming years.

It is in this concept that shareholders will perform fundamental analysis on historical and present data with the goal of making financial forecasts. The shareholders will thus need the financial statements which will help them to conduct a company stock valuation and predict its probable price evolution, make a projection on business performance, evaluate the business management and make internal business decisions and they will also be in a position to calculate the business credit risk (Best, 2010). To a serious shareholder, income statement analysis reveals much more than a company’s earnings.

It provides important insights into how the management is controlling expenses effectively, the amount of interest income and the amount of tax paid. The income statement can be analyzed to calculate financial ratios that will reveal the rate of return that the business is earning on the shareholders’ retained earnings and assets. This tells them how the business is using their investments in generating returns. The shareholders can also compare a company’s profits to its competitors by examining various profit margins. These would include the gross profit margin, operating profit margin, and the net profit.

These margins can also be compared to the industry’s profit margins which give the shareholder information regarding the company’s performance as compared to the industry it operates in (Kennon, 2010). According to Harper (2010), shareholders and lenders supply cash (capital) to the company. They therefore have claims on the business and the balance sheet is a good source which tells them of their funding. It is an updated record of the capital which is invested in the business. Lenders hold liabilities while shareholders hold equity.

The equity claim is residual, that means shareholders own whatever assets remain after deducting liabilities. The balance sheet is thus very resourceful to the shareholder as it informs him of the amount of capital raised through equity, debt, and retained earnings. The shareholder can get information regarding the percentage of income attributable to the shareholder of which it is retained by the business. Increase in this percentage means that the amount of dividends to be received will de reduced proportionally. This aspect has significant effect on the shareholder in regard to whether he is a short term or long term shareholder.

When the business has financed its operations by quite significant amount of debt, it means that the shareholders’ earnings in form of dividends will be reduced. This is because a higher percentage of the business income will be used in financing debts and paying interests to the creditors. A balance sheet can warn of potential problems and when used correctly, it helps to determine what a business is really worth. It tells a shareholder how much the company has, how much it owes and what is left for the stockholders (Kennon, 2010).

Cash Flow Statement “follows the cash” according to three core activities. Raising cash from capital suppliers, it is used to buy assets and it is used to create profit. This gives us the net cash flow. Debates have risen on how cash flow is useful to a shareholder, but in the short run, earnings move stock prices because they modify expectations about the long-term cash flows. Earnings might not be a fundamental factor that determines the intrinsic value of a stock, but they matter as a behavioral or phenomenal factor in impacting supply and demand (Harper, 2010).

Conclusion The financial statements may contain past and present information about a company’s performance, but they are very useful to the shareholders. This is because the shareholders are able to use accounting ratios to forecast the future trends and performance of the company. They can also be used to highlight bottlenecks that exist in the management decisions and policies adopted by the management which would have adverse effects on the welfare of the shareholder. References Best, B. , (2010) The Uses of Financial Statements.

Retrieved 12 May 2010 from, http://www. benbest. com/business/finance. html Harper, D. , (2010) Financial Statements: The System. Retrieved 12 May 2010 from, http://www. investopedia. com/university/financialstatements/financialstatements2. asp Kennon, J. , (2010) Purpose of the Income Statement. Retrieved 12 May 2010 from,http://beginnersinvest. about. com/od/incomestatementanalysis/a/income-statement-analysis. htm Shoaf, V. , (2010) Financial Statements. Retrieved 12 May 2010 from, http://www. answers

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