Why Read Financial Statements?Financial Statements
Financial statements are widely distributed by nationalized, private, and public sector companies. The readers are those who typically are impacted the most by the corporations. This includes Shareholders, Lenders, Employees, Unionized groups, Management, Governments, Tax Agencies, Customers, and Competitors. Other groups include advisors to groups impacted by investments. This typically concerns credit rating agencies, auditors, analysts, and advisors. All of these groups should read through differing sections of the financial statement.
Stockholders, also called Shareholders, own sections of the company. Their net worth is directly impacted by the success or failure of the company in question. They generally are small private individuals who own small to medium sized portions of the company. However, some are large institutions such as parent companies, banks, mutual funds, or retirement pensions. Both groups are interested in long term returns. They will assess patterns within the firms, and determine the likeliness that there will be strong returns or dividends. They’re concerned about downwards trends which inhibit capital growth or dividends.
Analysts and Advisors deliver recommendations to stockholders on which shares to purchase or avoid. They look for precisely the same things which investors look for, the ability to generate returns in capital gains, or returns in dividends, over long terms. They are trained to look beyond the simple areas that individual investors review. Usually, Analysts specifically study a firm or industry for an extended period of time and understand the meanings of trends in the financial statements at deeper levels. If the strategy looks out of place, they will point it out to investors. A critical part of their ability to deliver reports on company quality is reading and understanding the financial statement.
Lenders extend credit terms to the company, both long-term (over a year) and short-term (under a year). These groups are essentially concerned only about the ability of the firm to pay them back for the duration of their loans. They aren’t necessarily worried about capital growth or dividends; most successful companies are easily able to repay credit extensions. These credit extensions are not always only cash; people may loan supplies to be repaid at a later date. This qualifies as a form of debt for the company. Lenders will look at financial statements to ensure a firm can repay interest and principal. This requires having adequate cash flow or liquidity. They may also check the equity to leverage ratios, also known as the “gearing” of the firm.
Management teams which run firms form one of two internal groups which check financial statements. Management teams must look ahead of the curve. They need to be able to anticipate future results and ensure the firm remains financially sustainable. Their predictions often come from the results of the financial statements. Additionally, due to the opinions of all other groups that read them, management needs to be on top of the potential impacts of their financial statements. Their statements also impact themselves. Their pay, bonuses, and perks often rest on how well the firm performs, which is documented throughout its financial statements.
Employees are the second internal group which uses financial statements. Most employees can’t read financial statements, but those who can often desire to read them. Employees need to ensure their future remains secure, and that the future of their life security is reliable. Additionally, Employees may belong to Unions. These Unions bargain collectively for the wages of all their employees, often in correlation to the salaries of management or the profits of the company. They find this information in financial statements.
Competitors of a firm also use its financial statements. Companies use enemy statements as a benchmark for their current financial status. While revealing strengths, these documents also reveal weaknesses. They reveal strategies or markets that could be financially profitable for a company (or its competitors). Firms avoid revealing excessive business details in these documents, but sometimes details must legally be included. Competitors or investors may find a firm ripe for acquisition by reviewing their financial statements.
Government and Tax Agencies
Governments require that companies submit to taxation annually. Firms submit financial statements to determine (or justify) their taxation. Taxes are derived from strict versions of these documents. The exact system varies with the nation. Some tax directly on reports, others do not and use varying mathematical assumptions.
Customers of a firm might also be paying careful attention to these reports. This likelihood increases with their reliance on the firm. They may be a purchaser from the company with a long-term contract to use a firm’s products while manufacturing, such as Airbus or Boeing. If a firm which supplies crucial parts to the company fails, the customer will be forced to make rapid adjustments to fix their logistical problems. This is the same for companies selling to other businesses. A firm might earn its profit from a few business clients. If one of those clients financially fails, they could lose large amounts of revenue. A quarterly review of financial situations of both suppliers and purchasers helps firms determine if they should continue to rely on current connections or find new ones.
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