Question

Managerial FOCUS 1. An officer of Westway Corporation recently commented that when he receives the firm's financial statements, he looks at just the bottom line of the income statement-the line that shows the net income or net loss for the period. He said that he does not bother with the rest of the income statement because it's only the bottom line that counts." He also does not read the balance sheet. Do you think this manager is correct in the way he uses the financial statements? Why or why not? 2. The president of Brown Corporation is concerned about the firm's ability to pay its debts on time. What items on the balance sheet would help her to assess the firm's debt-paying ability? 3. Why is it important that a firm's financial records be kept up-to-date and that management receive the financial statements promptly after the end of each accounting period? 4. What kinds of operating and general policy decisions might be influenced by data on the financial statements?

Answer 1

1. The manager is no correct in just seeing the bottom-line of net income to check performance of the company. The financial statements of the firm are comprehensive which helps in understanding the performance during a given period. It helps in understanding how Sales and costs are moving along with the various types of margin like gross margin, operating margin and net profit margin. The business has to be understood as a whole and not in isolation by looking at specific line item like net profit. The Balance sheet helps in understanding the assets, liabilities and equity position as on a given date. The cash flow statement helps in understanding movement of cash during the year.

2. The Debt-Equity ratio helps in understanding the ratio of total debt to equity. The higher the ratio the higher is risk of solvency. Solvency refers to the ability of a firm to repay its debts on time. In addition to this current ratio helps in understating the ability of a firm in having liquidity to repay its short term obligations like current liabilities

3. The financial records of the firm help in preparation of financial statements at the end of the accounting period. There are a lot of regulatory requirements in financial reporting with certain timeliness. Also the annual financial statements should be communicated to the shareholders in the form of an annual report. Hence it is important to keep the financial records up to date so that financial statements can be prepared at the end of the accounting period. The management also should get the financial statements to comment on the same as part of management discussion and analysis report. The top management is responsible for the true and fair view of Balance sheet

4. The following operating and general policy decisions are influenced by data on financial statement

· The margin earned by the firm in the business and whether it should be improved compared to peers

· The net working capital of the business

· The financing done for purchase of assets and how to raise the additional funds if any needed

· The return on total assets and asset turnover ratio to see if assets are efficiently used in the business for generation of turnover

· Cash availability and how it is utilised in the business for example : Investments, dividend payments, etc

· Inventory days on hand helps in understanding how many days of inventory should be on hand to meet the customer requirements and manage working capital

· Accounts receivable and collection policy of the receivables