Prior to the adoption of the current Gregorian calendar, there was a time when April 1 was celebrated as New Year’s Day, coinciding with the turn of the vernal equinox or the welcoming of spring. Presently, the day is greeted with pranks and jests, a time to share laughter and respite from the hustle and bustle of daily work. For accountants and tax advisers alike, we mark the 1st of April as the start of the 15-day countdown, drawing nearer to the end of another long audit season to be culminated with the submission of financial statements and tax returns.
Indeed, financial statements have considerably evolved through the years from changes in terminologies (e.g. balance sheet to statement of financial position), the imposition of additional regulatory disclosures on taxes, inclusion of sensitivity analysis on economic indices such as interest and foreign exchange rates, and to the introduction of new jargons (e.g. amortized cost). The evolution resulted in the financial statements from being a simple 10-pager to a voluminous text that general users are not able to easily digest and understand. But it certainly cannot be denied, that these developments led to the presentation of more numbers and figures, which can only become relevant if read beyond the peso and dollar signs. Similarly, there is less noticeable information that offers hints and clues of stories wanting to be told if analyzed properly and paid more attention to by stakeholders and readers of the financial statements.
The fourth statement
Just because the statement of cash flows is the last presented does not make it the least valuable among the face statements. On the contrary, its three subtotals of operating, investing and financing provide a glimpse of a company’s current opportunities and challenges, business plans and strategy.
In the case of ABC Corporation, a regular manufacturing company within the XYZ group of companies, its management should be able to use the information on operating cash flows to evaluate key turnover ratios, particularly how an entity manages liquidity and strikes a balance between collection and payment terms with customers and suppliers, respectively.
Its shareholders, on the other hand, could use the information on the level of fixed asset acquisitions under investing activities to determine whether the company is positioning itself for expansion, or if capital projects are only within the normal course of replacing worn-out and fully utilized property and equipment and whether such is consistent with the plans of the company. Financing, on the other hand, may manifest management’s gamble on loans as a means of driving growth at the risk of incurring a greater loss should interest fluctuate unfavorably.
The disclosures on related parties within the XYZ group of companies paint a clearer picture of the whole organizational structure of a group of companies, identify the role an entity plays in the family and entire value chain, and infer how closely knitted relationships are. The information on volume of transactions, for example, allows the shareholders to gauge interdependencies and determine how much an entity relies on its parent or sister companies for financing (advances and loans), sourcing of supplies and materials (purchases), support (management and technical fees), and product marketing (sales). The additional disclosure requirement of the SEC on description of the relevant terms and conditions of each transaction including, among others, expected mode of settlement, credit terms and rates, also facilitate benchmarking and initial assessment on market comparability.
Although the presentation on tax reconciliation would not directly spell management’s tax strategy, the disclosure alternatively provides an entity’s effective tax rate, compared with the statutory corporate income tax rate of 30 percent, and itemizes the varying reasons that led to such variance. More often than not, these reconciling items are attributed to accounting treatments taken that directly impacted the income tax calculation and enables better understanding of an entity’s policies vis-à-vis tax laws and regulations. The reconciliation may also identify nondeductible and nontaxable items, which may signify non-recurring activities and management’s position on these transactions. Such disclosure could provide shareholders information on how effectively management is able to plan and implement its tax strategies.
Conversely, the total income taxes disclosed by entities must not be interpreted as their sole contributions to the local economy and to government coffers. It may be an indication, but not a true measure due to other variables that need to be considered, including employment, taxes and levies imposed by other agencies and prevailing economic conditions.
Critical estimates and key judgments taken by the management are also outlined in the note disclosures. Unfortunately, the discussions sometimes mirror images of accounting policies already described in other sections of the financial statements, and so appear very generic and universal. Nonetheless, the mere identification and enumeration of these estimates and judgments must already prove useful in pointing to the right direction where deeper scrutiny and review should be undertaken by shareholders, and knowing which account balances were significantly affected by these decisions made by the management.
There are definitely still a number of other notes and information that can be further digested, such as maximizing comparatives to evaluate fluctuations and identify potential business changes, taking a closer look at catch-all totals denoted by terms namely, ‘others’ and ‘miscellaneous,’ and reviewing liquidity and market risks (e.g. commodity prices) and how an entity intends to respond to these.
By reading between the lines, users, hopefully, may better recognize the stories behind the figures and the overall plot written by management, and render the financial statements transparent and not submerged under sublime text and confusing amounts. Essentially, the examination of financial statements should not only be limited to net income or the bottom line or a perspective of business reduced to a representation in number, but an expression of an organization’s culture, aspirations and goals.
And so, as we march toward another date with April 15, we wish you happy reading and a better appreciation of the financial statements, so no April Fools ever could affect you in this regard.
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Pocholo C. Domondon is a Partner from Assurance, Deals and Corporate Finance and also the Markets Co-Lead for Priority Targets of Isla Lipana & Co./PwC Philippines. Email your comments and questions to firstname.lastname@example.org. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.