Understanding financial statements, and their role in business planning

Over the past weeks, companies, especially banks, have been publishing their end of year financial statements. Banks and other firms, especially those listed on the Rwanda Stock Exchange, are required by law to publish financials regularly (quarterly) to show the public their financial health (or lack of it). For others, financial statements help track performance and identify gaps and intervention areas. That’s why every business, be it a small-and-medium enterprises (SMEs) category, or the big national or multinational firms, must make it part of their corporate culture to make financial statements on quarterly, bi-annually or on yearly in order to ascertain their financial status, among other things. Remember, financial statements are a representative of formal records of financial activities of an entity, company or any other business organisation. Financial statements reflect the financial effects of business transactions and events on the entity. They include profit and loss account, also known as income statement; balance sheet – which reflect the financial position of a business; statement of retained earnings or statement of change in equity, and details movement in owner’s equity over a period and also the cashflow statement – which shows the movement of cash and bank balances over a period of time and takes different forms depending on the purpose. All the financial statements of an entity have got a link and they constitute a financial report. A mistake in one of them leads to wrong results in the report. This, therefore, call for attention when preparing financial statements, and the statement must be prepared in a manner and form which is easy to understand and interpret. All financial reports must be prepared according to international financial reporting standards issued by the International Accounting Standards Board (IASB). So, when preparing proper financial statements, all the financial transactions of a business must be clear and well-documented. Different entities have got different financial statements, depending on the nature of activities they are engaged in; some make simple statements while others make consolidated ones. Though financial statements are prepared for owners or shareholders of any given company, other stakeholders and investors have varying interest in the financials of your company. Government departments, such as the tax authority or government regulators have interest in financial statements because they want to ensure that your company pays taxes, or that if the company fails, not a significant part of the liabilities will pass to the taxpayers. Today, regulators are keen to avoid what happened to financial industry in America in 2008, whose real performance led to significant debt being transferred to the state. Because the sector was not fully, controlled by regulators; lenders gave out funds without control, leading the financial crisis in the US and Europe, with its far-reaching effects on other countries, including Rwanda. The credit crunch frightened consumers and businesses as they perceived the financial system in America and Europe to have failed before it collapsed. This led to nationalisation of some financial institutions. That’s why it is important for regulators to keep an eyes on financial statements of some institutions. Employees want to work for a progressive and financially-stable institution for their job security. One’s job security depends on profitability, financial stability and viability of the company. Therefore, workers are interested in the income statements and the balance sheet of the company. A company experiencing problems is likely to lose staff, particularly the most experienced and talent ones. Staff turnover may hasten a struggling company’s decline. Creditors, those people and entities the business or organisation owes money. These entities are also interested in your financials, and mostly the balance sheet since it is from the balance sheet that they can use to gauge the financial strength or weakness of the company. A weak balance sheet or working capital is viewed as a warning signal to the creditors that there is a high probability of default. When the firm’s financial position is weak, shareholders, who are the owner of the company, may have to decide whether to continue holding the company’s shares or sell them. The financial statement interpretation is important as it provides meaningful information to the shareholders in taking such decisions. Also, the organisation’s management base on financial statements to make decisions and formulate plans and policies for the future. There is need to evaluate if performance and effectiveness of their actions will enable the company realise its goals, which managers gauge by referring to the financial statements. Potential investors will need to invest in institutions with strong and progressing financial statements. Investors are not investing in your business simply because they believe in your vision (though they do have to believe in it to invest), they are investing in your business to make a little bit of extra money as well. Having promising margins is going to be the best way to impress your investors, but having the numbers themselves is not everything. They (numbers) have to be presented in a pleasing, professional manner as well, which underlines the need to have clear financial statements as a business since they are a reference for numerous stakeholders. The author is an accountant based in Kigali. Email: vbahizi@yahoo.com

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Understanding financial statements, and their role in business planning