Accounts are prepared by all types of organizations whether listed, non-listed, government, NGOs (non government organizations), NPOs (not for profit organizations) or partnerships. Accounts are of different nature: they could be financial or cost and management. Each type serves its own purpose. Financial accounts are used by different external users to establish the viability of their interest in the company. This is explained later in the article.
Financial Accounts: These accounts reflect the financial and cash flow situation of an organization during a particular time period, and at the end of that period. The accounts are prepared according to specific standards which may vary from one country to another. Several countries have adopted IFRS (International Financial Reporting Standards) as preferred guidelines for accounts prepared by companies registered in their respective territory.
Financial accounts comprise of the following set of statements:
1. Profit and loss statement
2. Balance sheet
3. Cash flow statement
Profit & Loss Statement: This statement shows the Revenue and expenditure of the business and the resulting profitability or losses during the course of a defined period which is:
a) One year – This one year period statement is made to be published in the annual accounts of the company and is available to general public (in case of listed companies only) along with the companys stakeholders.
b) Interim – Interim statements are made for a period shorter than a year (in most cases it is half yearly statements) and these are made under specific situations for example if there is any regulatory requirement or there is a need by a set of companys stakeholders.
Balance Sheet – This shows the assets and liabilities of the organization at a certain date. The value of assets must be equal to the value of liabilities on that date hence the term Balance sheet. The liability section is the sum of companys capital amount and its liabilities and represents what the company owes to its creditors and owners.
Cash Flow Statement – This shows the actual cash inflows and outflows associated with transactions carried out during the year, for example sale and purchase of land or machinery, payments received from debtors or dividend paid to shareholders. This is different from the Profit and Loss Statement which includes non cash expenditures like depreciation on the fixed assets.
Cost and Management accounts – These set of accounts are prepared to be used by internal management to facilitate decision making for example to launch a new business line or to shut down an existing one, whether to increase or decrease production, defining budgets or forecasting future sales etc.
Users of Financial Accounts
The users could be categorized as general public and stakeholders. In case of non-listed company the users are the stakeholders only while the listed companys accounts are open to the public as well. The stakeholders are the parties who have a direct interest in the organization. Following are some of the key stakeholders:
a) Shareholders
b) Short term creditors (for example trade creditors and banks) and long term creditors( like bondholders, debenture holders and banks)
c) Government, regulatory authorities and tax authorities.
The accounts of the company, as represented in its financial statements, help such stakeholders to analyze the organizations financial position and make better decisions vis–vis their interest in the company.
Shareholders are interested in companys profitability, the earning capacity and its ability to continue the operations in future so that they can get dividends and capital gains. The long term creditors are interested in the long-term solvent position while the short term creditors on the other hand are more interested in the immediate liquidity of the company.
Short term creditors are interested in the company’s ability to pay them against invoices the creditors have submitted to the company for services provided or items sold to the company during the course of the year. For this purpose they will often look at the short term assets, such as cash, amounts due from debtors in the short term, inventories, etc., the company has that will help it make payments to the creditor.
Long term creditors are interested in the company’s ability to redeem long term commitments made between them and the company: these commitments often mature in more than a year. For this purpose, the long term creditor will often look at financial figures that will show how the company is investing its funds in revenue generating ventures that will help it fulfill its long term commitments.
There are several perspectives from which government entities can be interested in the accounts of a company. First, regulators may have stipulated certain financial conditions requirements on the industry the company is in or on the company in particular. For example, in the banking industry government regulators often require banks to hold a certain minimum amount of capital as a percentage of its liabilities in order to avoid catastrophic situation least there is a run on the bank. Other regulations imposed on the banking sector could be the amount of loans given out to a particular industry as a percentage of the total loans it has given out, or the maximum amount of loan that can be given out to individuals or companies in a particular sector. Second, government authorities often tax companies and the accounts will indicate how much the tax should be.