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Interpretation of Financial Statements

Interpretation of financial statements
Interpretation of financial statements

Interpretation of financial statements requires good skills to provide an accurate assessment of the health of an organization. While financial reporting is an annual statutory requirement for organizations of considerable size, it is first to guide business decisions. Top management is expected to devote a good time to review the management letter from the auditors. The audit committee is shadowed with the responsibility of monitoring the financial report and its accuracy. Once the audit exercise is completed, most organizations are only concerned with statutory filings. The focus should go beyond just filing for compliances and confirming the sales growth in the year. The interpretation of the financial statements is crucial. The numbers should be interpreted, detailing the strength, weaknesses, opportunities, and threats to the long-term goal of the organization. The board should demand a detailed report from the finance strategic team on their interpretation of the audited financial statements.

What to Look For

There is much information in the financial statements that could signal possible threats to the long-term objectives of the company. This might not be obvious at the face value but careful analysis of the number by experts could reveal this. An analysis over a 5-years period could show that no real value is being added despite revenue growth. A possible future cash-crunch situation could be revealed when the business growth and expansion strategy is juxtaposed with its liquidity. Management could proactively address this imminent challenge.  Understanding the returns on assets is sufficient to know how attractive the business is to a prospective investor. Some companies in Nigeria raised more than needed capital from the Nigeria Stock Exchange in recent years. This overcapitalization is revealed with a decline in their return on assets, over time, with the executives living lavished lifestyles.

Important of Non-Financial Information

Financial information, as well as non-financial information, is important in analyzing and interpreting financial statements. The notes to the account often contain non-financial information that could be relevant to understanding the health of an organization. We can deduce the level of employee morale by reviewing the rate of staff turnover and company investment in training. Recently, I reviewed a financial statement of a quoted company in Nigeria that has a policy “to train all staff at least once a year”. However, there was no major cost for employee training in their book despite the policy commitment over a 2-years period. The employee’s feedback on social media was not positive about how they were treated, working longer hours without overtime pay.

Many companies are currently going through their 2021 audit exercise, the exercise should be value-adding. The management letter from the auditors that shows the area of the business that require improvement should not be discarded. Top management should not receive such a letter from the auditors and dump it. Let the audit committee review the management letter and ensure the recommendations of the auditors are implemented. The review of the financial statement and its interpretation would help the management makes informed business decisions. As board chairman, that you sign the financial statement shows that you confirm your agreement and understanding of the report. Demand action to ensure necessary filings follow: Country by Country Report, Transfer Pricing Disclosure, and documentation, tax returns, etc. Failure to do these could result in massive penalties that would only drain the company financially.

Joshua Adeyemi (EMBA27)

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