22.1 Disclosures and Analysis: Overview
The underlying purpose of the financial statements is to tell a story about the operations of a business from its inception to its dissolution. What stories could China Animal Healthcare’s financials tell had they not been stolen, and how might this event affect investor and creditor decisions? Given the complexities in today’s marketplace, decision-making for creditors and investors can be quite challenging. Financial statements only have meaning, and therefore appropriate influence, if they are complete and if users know how to interpret them. Appropriate disclosures and financial statement analysis are an important part of this evaluative process.
To aid users in understanding financial statements, most medium to large businesses prepare extensive disclosures in the notes to the financial statements. In addition, monthly or quarterly interim financial statements are often prepared that provide an early warning system for management and other select users, such as creditors, who monitor debt and compliance with restrictive covenants. Additionally, if business activities are diversified, segmented reporting is another financial report that separates business operations into segments such as geographical operations or various business lines. This allows stakeholders to determine which segments contribute the most to the overall business.
To assist with the task of a thorough financial statement assessment, there are several analytical techniques available to stakeholders. These include ratio, common size, and vertical and trend analysis. Actual results reported in the financial statements can be compared to the business’s own strategic forecast and to industry competitors to see if it is keeping pace, growing, or shrinking.
Understanding a business, however, is more than just analyzing the core financial statements. Business stakeholders need to consider the quality of management, the overall industry climate, as well as projected economic developments. This information comes from many different sources such as the notes to the financial statements and the management discussion and analysis (MD&A) report, which presents information about the operations, company liquidity, capital resources, economic outlook, and any risks and uncertainties. Independently prepared reports such as auditor’s reports, analysts’ reports, economic reports, and news articles are also an important source of information.
The purpose of this chapter is to focus on the bigger picture of a business’s overall current financial performance through the accurate interpretation of the financial statements and their disclosures.
