The financial statements are not telling us enough?

Our students are often asked, “What are the various financial statements?”

The five statements are:-
  • Balance Sheet
  • Income Statement
  • Notes to the Account
  • Cash Flow Statement
  • Statement of Changes in Equity
In a study by the Economic Intelligence Unit (EIU) and Deloitte last year, it suggested that financial statements – in their present format – do not provide a complete picture of the soundness of a company.

The study calls for financial statements to reflect both financial and non-financial indicators of a company’s health.

The Americans set the pace with the Sarbanes-Oxley Act in response to the collapses of Worldcom and Enron. The Act is a set of rules that are targetted more towards severe corporate misbehaviour, eg. fraud and the falsification of accounts.

The EIU-Deloitte study showed that ‘traditional’ financial measures fail to reflect the state in the more mundane but critical non-financial areas.

Some examples of these non-financial areas cited:-

  • What are company’s relationships with important parties, such as customers, employees and suppliers?
  • Are the products of company of certain quality?
  • Are your employees committed to the company?
  • What is the key source of future revenue and profit in a firm?
  • What is the state of product innovation?
  • What is the level of brand loyalty and strength?
  • What is the level effectiveness of the board and top management?

Most of the white-collared executives surveyed in Europe said they would prefer to see more incisive information on their companies’ key non-financial drivers of success.

How to make such information on key non-financial drivers a reality?

  • Set industry standards to measure these crucial drivers. Without such standards, reliability of such information would be a big concern.
  • Coerce a mindset change in companies that non-financial measures do affect profitability. I believe the companies will get the message when the market reacts to such information compared across companies and industries.
  • It is also important to have board members and executives who are knowledgeable about non-financial measures. In similar vein, the scope of auditing would expand too and will thus require the necessary expertise beyond accounting and/or auditing.

These non-financial measures would help us to see the company’s future prospect better.

Reference – “Inadequacies of Financial Statements”, Business Times, Michelle Quah, February 4, 2005.

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