Question

In your Financial Management: Theory and Practice text, complete the mini case on page 133.  Evaluate the implications of accounting and financial information in measuring and projecting organizational performance and motivating and controlling the firm's management. Analyze ways in which leaders and managers make decisions using accounting and financial data.

Answer 1

• The leaders and managers of all businesses, big or small, use the accounting and financial data for analysing, evaluating or confirming their understanding of the business and how it is functioning.
• Each ledger account in the books of accounts, either individually, or read in combination with other accounts tells more about the health of the business, which may not be apparent, but nonetheless true.
• Financial Statements of a business assess its profitability, liquidity and operational efficiency. There are many more reasons and uses of analyzing financial data.

The below mentioned are some of the ways in which leaders and managers make decisions using accounting and financial data.

1. To assess the financial performance of the business as compared to last year. - The Balance Sheet and Income Statement are used to assess the current year's performance with the last year. What are the increase/ decrease in Sales, costs, assets, liabilities, etc. Have the business achieved its financial goals set by the leaders in the beginning of the year. If it has under-achieved them, then by how much and due to what reasons? Is it due to reduction in Sales or is it due to reduction in profit margins that the business could not achieve the target profits? Such important questions are answered by the Financial Statements.
2. Changes in the Cost mix of the business. The common size statements show all items as a percentage of a common base figure, eg. Sales, which comes very handy in assessing the resources spent towards various core and ancillary activities. It also tells which costs have increased or decreased over the year. This gives the managers the clue to reassess if the expenditures made by the business were wasteful, or is it that that the new costs are springing up due to business environment, and should be planned and budgeted for the coming year.
3. Strategy and Benchmarking. The leaders compare their current year's financial statements and internal reports with previous years' statements to understand how the business is heading. They may also compare their financial report with their competitors' to plan their strategy ahead, and also to adopt some better practices that the competitors are using.
4. Cash position in Short term. The cash flow statement helps in evaluating whether the business has enough cash to pay its short term obligaions in time. The operating cash flows also tell, whether the business is making enough cash flows to sustain itself, or if it requires more working capital.
5. Liquidity Ratios. The liquidity ratios, including the Current Ratio and Quick ratio help to assess the liquidity position of the business better, in addition to the Cash flow statements.
6. Activity/ Turnover Ratios, like stock turnover ratio, debtors turnover ratio, fixed-assets turnover ratio, help in determining the ability of the business to convert its balance sheet accounts into revenue.
7. Profitability Ratios, including Gross Profit Ratio, Operating Ratio, Net Profit Ratio, Return on Equity, Return on Investment/ Capital employed help in determing the profitability of the business from various perpectives including that of the owners and business as a whole.
8. Solvency Ratios, like Debt to equity ratio, Proprietary ratio, Capital gearing ratio, debt service coverage ratio, etc help in determing the extent to which the assets of the business cover its payment of liabilities, more importantly the debt obligations.
9. Other reports containing various measures like Employee turnover ratio (help in determining whether the employee turnover is as per the industry or worse), the corporate social responsibility report (what is the business doing for the society as a whole, where it is operating its business) and various other reports are also helpful for the leaders to decide the future course of business and their decisions, as the profitability and sustainability are very important, but taking care of the employees and the society is what makes a business to move forward and grow bigger and better. These reports are also prepared and validated using the accounting data.

There are various other metrics and uses of accounting and financial data. The more we delve, the more we get to know about the business and its environment from the accounting and financial data.