ATENEO DE NAGA UNIVERSITY GRADUATE SCHOOL OF BUSINESS

NAGA CITY

Reflection PaperOn

Basic Financial Statement: It’s Importance

By:Policarpio R. Malonda

Summer 2007

Objectives:

To be able to discuss the importance of Financial

Statements in making sound management decisions and

evaluating the over all performance of the company

in meeting its objectives.

Discussion:In the private sector, the

General Manager’s primary goal is to maximize the value of is or her firm’s stock while investors are very particular about the security of their investments. They used both qualitative and quantitative data to track the operation of the business. Most of these data are found in the annual report.

Qualitative data includes description of the firm’s operating result during the past year and discusses new developments that will affect future operations. Quantitative data are the accounting pictures of the firm’s operations and financial positions; these are usually reflected in the financial statements.

In the public sector the utilization and disposal of the government funds and properties whether local or national level are also reflected on their annual year financial reports

For the Purpose of this paper company refers to private and public corporations. I will also be using theories intended for both private and government sectors but the examples exhibited were taken from the government actual financial reports for calendar year 2006. These reports are mandatory requirements for reportorial purposes and transparency of all government transactions. Failure to submit this report have corresponding sanctions provided by law.

Philippine Accounting Standard (PAS) defined financial statements: “As the means by which the information accumulated and processed in financial accounting is periodically communicated to those who use it”.

For the private companies the primary users of the financial statements are the managers, owners or investors, the creditors and the government. Through the aid of these statements they could picture the firm’s profitability, financial position and conditions, safety ness of the investment, accuracy of tax payments and the overall performance of the management in running the operation of the business.

In the public sector financials statements users includes, Local and national officials whether elected of appointed in the positions, the Department of Budget and Management, the Commission on Audit, the Congress and the Senate and the Office of the President and more. All of these users used the year end annual financial reports to assess the effectiveness and efficiency in administering the government operations.

Financial Statements also serve as the communication link between the company/government and various interested parties like the suppliers, customers, local and foreign investors, creditors which includes banks and other financial intermediaries and many more.

Any misrepresentations in these financial statements have tremendous effect on its users.

For the private sector a good example of this is the story about the Enron; in the early 2001 Enron appeared to be on top of the world. The high flying energy firm had a market capitalization of $60 billion, and its stock was trading at $80 a share. Wall street analysts frequently touted its innovations and management success, and the most strongly recommended stock in the world market.

Less than a year latter, Enron had declared bankruptcy, its stock was basically worthless, and investors had lost billions of dollars. The dramatic and sudden collapsed left many wondering how so much value could destroyed in such a short period of time.

Story revealed that the company “cooked its book” and inflated its profits and cash flows. Financial Statements are been misleading and so many users had been deceived.

All of this had led to a series of investigation that will almost certainly results in new guidelines and regulation regarding the construction of financial statements.

For the public sector the strict examination of the Commission on Audit on the accuracy of these statements had been in placed to prevent such scenario.

A complete set of basic financial statements includes the following components: 1) Balance sheet; 2) Income Statements; 3) Statement of changes in equity or statements of recognized gains and losses; 4) cash flow statements; 5) Notes to the financial statements.

Balance sheet (Exhibit 1) is the formal statement showing the financial position of an entity as of a particular date. It presents the three elements of financial position, namely assets, liabilities and equity. Creditors, Investors and other users analyze the balance sheet to evaluate the liquidity, solvency, financial structure and capacity for adaptation of the business.

Liquidity is the ability of the entity to meet currently maturing obligation, solvency is the availability of cash over the longer term to meet maturing obligations. Financial structure is the source of financing for the assets of the entity and capacity for adaptation is the financial flexibility of the entity to use its available cash unexpected requirements and investment opportunities

Financial flexibility may be accomplished by raising cash at short notice through borrowing or issuance of securities or by raising cash through disposal of assets without disrupting normal operations.

Income statements (Exhibit 2) is a formal statement showing the performance of the entity for a given period of time. The performance of the entity is primarily measured in terms of the level of income earned by the entity through the effective and efficient utilization of its resources.

Information about the performance of an entity, in particular its profitability, is useful in predicting the capacity of the entity to generate cash flows from its existing resources. It is also useful in forming judgment about the effectiveness of employing additional resources.

Statement of changes in equity (Exhibit 3) had been divided into two parts by Philippine Accounting Standard (PAS 8) namely: 1) Change in Accounting Estimate and 2) Change in accounting policy. The effect of a change in accounting estimate shall be recognized currently and prospectively by including it in income or loss of the period of change if the change affects that period and the period of change and future periods if the change affects both.

The effect of change in accounting policy shall be applied retrospectively, means that any resulting adjustment from the change in accounting policy shall be reported as an adjustment to the opening balance of retained earnings.

Cash Flows Statements (Exhibit 4) shows the actual cash flows generated by the entity for the year. It usually contained three main areas: 1) cash flows from operation, 2) cash flows from investments, and 3) cash flows from financing transactions, such as issuing stock and borrowing or repaying debt. Information about cash flows is useful in order to assess the

Notes to the financial Statements (Exhibit 5) composed of a summary report of significant accounting policies and explanatory notes. These are information that does not fit into the body of the statements in order to enhance the understandability of the statements. They provide additional information and help clarify the items presented in the financial statements. Notes provides a narrative description or disaggregations of items disclosed in the financial statements.

In general the purpose of the notes to financial statements is to provide the necessary disclosures required by the Philippine Financial reporting standards. Specifically the notes to the financial statements of an entity shall: 1) Present information about the basis of preparations of the financial statements and the specific accounting policies selected and applied for significant transactions and events,

2) Disclose the information required by Philippine Financial Reporting Standards that is not presented in the face of the financial statements, 3) Provide additional information which is not presented on the face of the financial statements but is relevant to an understanding of the financial statements.

The notes to financial statements should be highly detailed, precise, complete and easily understood by a reader who was a reasonable understanding of business affairs.

In presenting the notes to the financial statements it must be in order as follows: 1) statement of compliance with GAAP, 2) Summary of Significant accounting policies applied, 3) Supporting information or computation for line items presented and aggregated in the financial Statements, 4) Other disclosures, such as commitments, contingent liabilities, and other financial and non financial disclosures.

Truly financial statements are helpful tools in making sound decision making but it has some limitations which includes: 1) Variations in application of accounting principles- although financial statements are prepared in accordance with GAAP, the application of these principles vary because of the different methods that may be used in income statements and in determining the financial condition of a business,

2) Financial statements are interim in nature although they give an impression of being accurate- statements are prepared only for an accounting period and not for the entire life of a business entity, 3) It does not reflect changes in the purchasing power on the monetary unit, 4) It does not contain all the significant facts about a business- recorded transactions, other information such as the quality of organization, location, and quality of demand for its products are not included therein.

Although financial statement is not by no all

means perfect, it is an important source of information to assess the entities activities.

Thank you!

References:Roque, Rodelio, Managerial Accounting System, Roques Press Inc., Malabon Metro Manila, 2000

Valix, Conrado T. and Jose Peralta, Financial Accounting, Volume 1, GIC Enterprises & CO., Inc., Manila Philippines, 2006

Valix, Conrado T. and Jose Peralta, Financial Accounting, Volume 2, GIC Enterprises & CO., Inc., Manila Philippines, 2006

Brigham, Eugene F. and Joel F. Houston, Fundamentals of Financial Management, Tenth Edition, Thomson Learning, 2004

Scott, David F. Jr., John D. Martin, J. William Petty, Arthur J. Keown, Basic Financial Management, Pearson Education Asia, Prentice Hall, Inc. Upper Saddle River, New Jersey. 1996

Manual on the New Government Accounting Systems (NGAS), Volumes 1, Volume 2 and Volume 3

Manual on Electronic New Government Accounting Systems (E-NGAS) Volume 1

Mejorada, Neneiot D., Business Finance, Goodwill Trading Company Inc.,, Makati City, second edition, 2000