Session 1: Users and Suppliers of Financial Statements InformationSession Learning Outcome
Learners will be able to understand parties that demand and supply financial statements information as well as their objectives for the need of the financial statements information. Also, they will learn the conflicts which may arise among the diverse parties demanding and supplying the financial statements. Important Learning Terms - Demand
- Supply
- Financial statements information
- Internal users of financial statements
- External users of financial statements
A: Users/Demanders of Financial Statements Information
Parties demanding financial statement information include: - Shareholders, investors and security analysts;
- Managers;
- Employees;
- Lenders and other suppliers;
- Customers; and
- Government regulatory agencies
These parties can also be grouped into internal versus external users. Internal users consist of managers and employees while external users consist of the rest in the above list. These parties demand financial statement information: - To Facilitate decision-making,
- For Monitoring of management, or
- To Interpret contracts or agreements that include provisions based on such information.
Shareholders, Investors and Security Analysts
These are major recipients of the financial statements of corporations. These parties range from individuals with relatively limited resources to large, well-endowed institutions such as insurance companies and mutual funds. The decision made by these parties includes: - Shares to buy, retain, or sell,
- Timing of the purchase or sale of those shares.
Typically, their decisions have either an investment focus or a stewardship focus; in some cases, both will occur simultaneously. In an investment focus, the emphasis is on choosing a portfolio of securities that is consistent with the preferences of the investor for risk, return, dividend yield, liquidity and so on. The information required for this choice can vary significantly. An Illustration
Consider approaches aiming to detect mis-priced securities by a fundamental analysis approach as opposed to a technical analysis approach. The former approach examines firm,-industry-and – economy-related information; financial statements play a major role in this approach. An important aspect is predicting the timing, amounts, and uncertainties of the future cash flows of the firm. In contrast, technical analysis aims to detect mispriced securities by examining trends in security prices, security trading volume, and other related variables; financial statement information typically is not examined When predicting the timing, amounts, and uncertainties of future cash flows of the firm, the past record of management in relation to the resources under its control can be a critical variable. The analysis undertaken for decisions by shareholders and investors can be done by those parties themselves or by intermediaries such as security analysts and investment advisors. Note: These intermediaries can have different rankings for financial statement variables than the investors for whom the information analysis is conducted. Managers
One source of the demand for financial statement information by managers arises from contracts that include provisions based on financial statement variables. e.g. Management incentive contracts. When structuring agreements between the firm and other entities, management may include contractual terms based on financial statement variables. Managers also utilize financial statement information in many of their financing, investment, and/or operating decisions. A financial-statement based variable, such as the current debt-to-equity ratio or the interest coverage ratio, is frequently important in deciding how much long-term debt to raise. The financial statement of other firms can also be used in management decisions. For instance, when deciding where to re-direct the resources of a firm, the financial statement of other firms can show areas where high profit margins are currently being earned. Employees
Employees have several motivations. They have a vested interest in the continued and profitable operations of their firm. Financial statements are an important source of information about current and potential future profitability and solvency. They may also need them to monitor the viability of their pension plans. Lenders and Other Suppliers
In the ongoing relationship that exists between suppliers and a firm, financial statements can play several roles. Consider the relationship between a firm and the suppliers of its loan capital, e.g. a bank. In the initial loan-granting stage of the relationship, financial statements typically are an important item. Many banks have standard evaluation procedures that stipulate that information relating to liquidity, leverage, profitability, and so on be considered when determining the amount of the loan, interest rate and the security to be requested. Many bank loans include bond covenants that, if violated, can result in the bank restructuring the existing loan agreement. One effect of incorporating a covenant into a loan agreement is to create a demand by the bank for successive financial statements of the firm. Customers
The relationship between a firm and its customers can extend over many years. In some cases, these relationships take the form of legal obligations associated with guarantees, warranties, or deferred benefits. In other cases, the long-term association is based on continued attention to customer service. Government/ Regulatory Agencies
The demand by these bodies can arise in a diverse set of areas such as; Revenue raising, e.g. for income tax, sales tax, or value-added tax collection. Government contracting, e.g. for reimbursing suppliers paid on a cost-plus basis or for monitoring whether companies engaged in government business are earning excess profits. Rate determination, e.g. deciding the allowable rate of return that an electric utility can earn. Regulatory intervention, e.g. determining whether to provide a government-backed loan agreement to a financially distressed firm. For instance, telecommunication regulators may demand financial statements of the telephone/ICT companies to make decisions on the following issues: - Competition strategy set up of the companies
- Monitoring interconnection charges
- Limit entries and incubators in the market
- Deciding on the coverage
- Setting the upper pricing limit for the services provided by the operators.
- For industrial/regional comparisons of the services offered by the companies and the returns of the companies.
Other Parties
The set of parties that make demands of the financial statements information of corporations is open-ended. Diverse parties such as academicians, environmental protection organizations, and other special interest lobbying groups approach corporations for details relating to their financial and other affairs. B: Suppliers of Financial Statements Information
Business firms are the suppliers of the financial statements information. Limited liability companies are required by the company act to prepare financial statements and disclose the audited financial statements to the public/shareholders. Listed companies are required by the regulations governing the operation of the stock market to disclose audited financial statement information. C: Conflicts among Diverse Parties
As explained in part A of this section, users of financial data have diversity of interests. These interests sometimes conflict. Owners/Shareholders
The interest of these parties in financial statement information lies in the fact that it is their money that is invested in the firm. They would like to ensure that they are getting a good return on their investment. This is assessed by how much profit the firm is making and whether their investment is increasing in value. For shareholders in companies this means they will get good dividend and the market value of their shares will increase and they can make capital gains if these were sold. Management
They are responsible to the owners/shareholders in carrying out policies and directives, and in running the business efficiently and effectively. They however, need to be paid well and this increases expenses and thus reduces returns to shareholders. Banks/Loan companies
This group is interested not only in the firm's profitability but also in its ability to repay loans. Managers would prefer using loaned funds for a longer period. Employees
They are part of the organization and feel that their efforts contributed to the firm's profits. They would therefore prefer to be given bonuses and salary increases. This also increases expenses to the firm. Suppliers
Suppliers usually extend credit to the firm for goods supplied and they want to be assured of timely payments of accounts due. Their interest will be similar to that of the banks and loan companies. Prospective Investors/Analysts
These are interested in a firm's profitability and potential for growth. Prospective investors rely on financial statements information in making their investment decisions. In giving advice to prospective and existing investors, analysts also make use of financial statements information. Government
Various ministries and departments have interest in the firm's payments of taxes. Also see the enactment of laws for the industry and provision of social services to the public. The government may also want to ensure that the firm complies with laws on, for example, wage payments and employee benefits. Discussion 4
Post your response in the discussions area. (See the procedure for discussions in Course Info.) 1. What are the possible conflicts in demanding the financial statement for a telephone operator for the following parties
a) Users of the service and the operators
b) Competitors and the shareholders
c) Shareholders and the users
d) Shareholder and the operator 2. Explain why each of the following groups might want financial statements information. What type of financial information would each group find most useful?
a) The company’s existing shareholders
b) Prospective investors
c) Financial analysts who follow the company
d) Company managers
e) Current employees
f) Commercial lenders who loaned money to the company
g) Current suppliers
h) Regulators in the sector like Telecommunication Regulators for the telecommunication industry | 
