Managers use a series of control methods and systems to deal with the differing problems and elements of their organizations. The methods and systems can take many forms and can be intended for various groups. However, financial controls have a special prominence, since money is easy to measure and tally. In this article, we will be discussing financial statements, which provide insight into an organization’s performance and long term prospects. Budgetary control methods which help managers control an organization’s financial resources and auditing which compares an organization’s expenditure to its budgets are not in the scope of this article.
Financial statements are used to track the monetary value of goods and services into and out of the organization. They provide a means for monitoring three major financial conditions of an organization:
1. Liquidity: the ability to convert assets into cash in order to meet current financial needs and obligations.
2. General financial condition: the long term balance between debt and equity (the assets left after liabilities are deducted).
3. Profitability: the ability to earn profits steadily over an extended period of time.
Financial statements are widely used by managers, shareholders, financial institutions, investment analysts, unions, and other stake holders to evaluate the organization’s performance. Managers, for example, could compare the organization’s current financial statements to past statements and to those of competitors as one measure of how the organization is doing over time. Given enough information, they might be able to see trends that require corrective action. Bankers and financial analysts, on the other hand, will the statements to decide whether they should invest in the firm.
It is important to remember that financial statements do not show all relevant information. Recent technological or scientific breakthroughs seldom show up on financial statements, for example. Nor do changes in the organizational environment, such as shifts in consumer tastes, even though could be more crucial to the organization’s success than its financial performance.
Depending upon the company, financial statements could cover the previous year, the previous quarter, or the previous month. The most common financial statements, used by large and small organizations alike, are income statements, balance sheets, and cash flow statements.
Balance Sheet: The message of a balance sheet is “Here’s how this organization stacks up financially at this particular point in time. The point in time covered by our sample balance sheet is indicated by the line “For the year ended December 31, 1994”. The balance sheet is a “snapshot” taken on that date.
In its simplest form, the balance sheet describes the company in terms of its assets, liabilities, and net worth. A company’s assets range from money in the bank to the goodwill value of its name in the marketplace. The left side of the balance sheet lists these assets in descending order of liquidity. A distinction is made between current assets and fixed assets. Current assets cover items such as cash, accounts receivables, marketable securities, and inventories – assets that could be turned into cash at a reasonably predictable value within a relatively short time period (typically one year). Fixed assets show the monetary value of the company’s plant, equipment, property, patents, and other items used on a continuing basis to produce its goods or services.
Liabilities are also made up of two groups; current liabilities and long term liabilities. Current liabilities are debts, such as accounts payable, short term loans, and unpaid taxes that will have to be paid off during the current fiscal period. Long term liabilities include mortgages, bonds, and other debt that are being paid off gradually. The company’s net worth is the residual value remaining after total liabilities have been subtracted from total assets.
The widespread use of electronic spreadsheets has made the preparation of balance sheets much easier. In addition, computer packages have been developed specifically to process accounting transactions and prepare the resulting balance sheets and other financial statements.