Financial statements usually present the picture of the financial health of a given entity. With that in mind, the importance of accuracy as far as financial statements are concerned cannot be overstated. It is hence critical for a business to come up with accurate financial statements not only for purposes of meeting internal reporting requirements but also for purposes of satisfying external reporting expectations so as to accurately deduce the entity’s financial health as well as address the various legal requirements. In this text, I discuss the reason why accurate financial statements are important for outside business interests.
The accuracy of financial statements
Needles et al. (2007) argues that in the recent past, two areas have been identifies as the greatest contributors to financial statements inaccuracies. This includes incompetence and secondly dishonesty. Therefore, it means that if the accuracy of financial statements is to be upheld so that a true and accurate picture of the entity can be presented both to the internal as well as outside business interests, measures must be taken to address these two sources of inaccuracies as far as financial statements are concerned.To begin with, incompetence usually manifests itself during the recording of transactions. According to Ingram et al. (2006), financial statements cannot be taken to be useful if they are founded on questionable or unreliable records. He continues to note that the ‘garbage in garbage out principle’ still applies as far as the recording of transactions is concerned in accounting cycle. This essentially means that the enhancement of the financial statements accuracy starts at the recording stage. If the recording of transactions is compromised, we cannot thereafter talks of accurate financial statements for use either internally or externally.
To address both the incompetence as well as dishonesty issues which are the main contributors to inaccurate financial statements and hence enhance the value of the financial statements to outside business interests, two solutions come to mind. One, it may be prudent for a business to engage the services of an audit firm to carry out an audit of the financial statements so as to ensure they are essentially accurate. During the auditing process, the various financial records as well as accounting balances are subjected to accuracy tests. The accuracy tests may be designed to look out for inconsistency in recording as well as reporting and secondly ascertain if the entity’s records are in conformity with the provisions of the Generally Accepted Accounting Principles (GAAP).Secondly, to enhance the importance of financial statements for outside business interests, it may be prudent for an entity to embrace or adopt internal controls that can be seen to be adequate. Internal controls include all the procedures as well as policies a business adopts for purposes of fraud prevention, safeguarding of the assets as well as the enhancement of accuracy as far as financial reporting is concerned.
The relevance of accurate financial statements for outside business interests
There are two main users of the financial statements a business generates. The first group of users includes the internal users while the second group is made up of the external users or outside business interests. The internal group is made up of amongst others the managers, owners of the organization as well as the employees. The external users of financial statements include amongst others the regulatory authorities, investors, competitors, bankers, customers as well as suppliers. According to Needles et al. (2007) accurate financial statements are especially more useful to outside business interests other that internal users because external users lack the day to day interaction with the enterprise.
The financial statements used mostly by outside business interests include the statement of cash flow, balance sheet or statement of financial position, income statements as well as tax reports.To begin with, accurate financial statements are extremely important to investors who may want to invest in a business entity. Accurate financial records help such investors to make investment decisions which are logical based on the information contained therein. It is important to note that investors need to come yup with a detailed evaluation of the viability as well as financial stability and strength of a company before making an investment. With that in mind, financial statements that make false projections about future earnings as well as the use of creative accounting to inflate earnings may hence mislead the investor as far as his investment decisions are concerned. With this in mind, the importance of accurate financial statements cannot be overstated as far as investment decisions are concerned.
Secondly, accurate financial statements are also very important for bankers. Bankers usually use an entity’s financial statements for a wide range of reasons. Chief among this is for purposes of determining whether or not to lend capital to a company; be it working capital or otherwise. To underscore the importance of accuracy as far as financial statements are concerned, banks demands that businesses in need of loans avail financial statements which are audited and prepared in conformity with the GAAP provisions. Banks may then utilize such statements for analysis including the computation of current ratios, debt-to-tangible-net-worth ratios as well as a wide range of other loan ratios. Accurate financial statements are also critical to bankers for purposes of advising their clients on where to invest and which investment opportunities to avoid. In this regard, bankers’ source audited as well as GAAP compliant financial statements to avoid making investment analyses for their clients based on faulty financial information.
Competitors also make up the other outside business interests who benefit from accurate financial statements. It is important to note that financial statements of a competitor may hold the key as to the probability of success or failure of a new entrant in the marketplace. Before a new entrant makes decisions on whether or not to take other competitors head on in the marketplace, it must first carry out a detailed analysis of the various players in the marketplace to chart its probability of success. This may be by way of coming up with a number of credit management, debtor, cash as well as productivity and efficiency business ratios. In other words, competitors need accurate financial statements for purposes of benchmarking their own performance based on the comparison of information contained in a competitor’s financial statements. It is hence clear that competitor analysis based on faulty or inaccurate financial statement information or data may set up a business for failure whether it’s a new entrant or an existing competitor.
Next, accurate financial statements are critical for regulatory authorities as well as government bodies. The legal provisions make it clear that companies should make annual submissions of all their financial statements on an annual basis. Tax authorities specifically need accurate financial statements so that they can come up with a tax analysis of the entities under consideration and ensure that the entities are paying tax as per their financial performance. The government finances its various activities through the collection of tax and as such must enhance the collection of taxes from businesses as well as individuals. The government through its tax authorities hence needs a presentation of accurate financial statements so as to derive the figures for the taxes payable and hence avert instances of tax evasion and illegal tax avoidance schemes.
Other outside business interests interested in accurate financial statements include suppliers. To guarantee the safety of their sales delivered on credit terms, suppliers usually carry out an analysis of a business’ financial statements to deduce their ability to repay. It is hence prudent for suppliers to rely on financial statements that present a true picture of the firm s far as its staying power is concerned.Other outside business interests interested in accurate financial statements include rating agencies for purposes of credit ratings assigning, labor unions to project pay increases a company can be able to handle in ongoing negotiations, major customers to establish whether a firm is a going concern etc.As noted earlier, the value of accurate financial statements cannot be overstated. Based on all those who rely on financial statements to make critical decisions as regards investments, lending etc as discussed in this text, all business entities should adopt working measures to ensure that all their financial projections present a true and reasonable picture of their operations.
In many ways, financial statements offer an essential glimpse into the financial health of business. It should however be noted that financial statements are only useful as at he time of their generation. In conclusion, based on the issues addressed in the text above, it is clear that it is critical for a business to come up with accurate financial statements not only for purposes of meeting internal reporting requirements but also for purposes of satisfying external reporting expectations as well as addressing outside business interests.
Needles, B.E., Powers, M., & Crosson, S.V. (2007). Financial and Managerial Accounting. Cengage Learning
Ingram, R.W., & Albright, T.L. (2006). Financial Accounting: Information for Decisions. Cengage Learning