Financial statements contain wealth of information which can be useful to the variety of readers and users of these statements. These users are called “Stakeholder” as they have some sort of stake (interest or risk) associated with the business. These stakeholders are the individuals or organisations who have some sort of interest, financial and/or non-financial, in the company’s affairs for various reasons. These stakeholders can mainly be categorised in the following three categories:
1.Internal
2.Connected
3.External
Internal Stakeholders
These are mainly employees and management.
Management
Management i.e., directors, especially the finance director, is mainly interested in the financial statement of the company as it is their responsibility to produce these statements.
It is the legal duty of the directors to produce financial statements. Countries around the world have different laws to regulate this matter. In the UK, Companies Act 2006 is the latest version of the act which requires the production of these statements. Finance Act is issued every year which also regulates parts of the financial statements. Fines are imposed on the company if these statements are filed late and failure to submit financial statements is a criminal offence.
These statements also provide information on management’s performance. Ratio Analysis can be used to assess the performance of various departments of an organization which is then used for the performance evaluation of managers in the relevant departments. Financial statements can also have a big impact on the market value of a company and consequently, on the management bonuses. Investors use these statements extensively to make decisions about selling or buying shares in a company which can fluctuate market price of the company’s shares. It is very common that management bonuses are dependent on the share price of the company. For example, Elon Musk, the owner of Tesla and SpaceX, earned $55 billions in bonus in 2020 by meeting the targets, one of which was to achieve a target share price.
Employees
Employees could be interested in the financial performance of the company for job security. A declining performance of the company could indicate job losses in future and such knowledge could help the employees to make decision on their next career move. Businesses in financial distress often make their employees redundant as we have seen during credit crunch in 2008 and during the Covid-19 pandemic. The information in financial statements can also help job seekers to assess if the company is good to work for. Such information can be helpful if a person has a job offer from various employers. A comparison of the financial information available in financial statements can be helpful to make decision on the matter.
Financial statements can also provide vital information to the trade unions to negotiate pay settlements. If an organisation is showing continuous improvement in the financial results, employees can claim higher wages as a result. Workers of many organisations have started strikes for higher wages after the release of financial results showing higher profits. For example, Amazon’s profits have increased significantly during the pandemic in 2020 which has resulted in demands for higher wages by its employees. Deliveroo’s IPO initially valued the company at £7.6 billion which resulted in strike by the workers for higher wages.
Connected Stakeholders
These are the stakeholder who have some sort of connection with the business but are not internal to the organisation. Example of connected shareholder are:
•Shareholder
•Lenders
•Suppliers
•Customers
Shareholders
Shareholders are the owners of a limited company and they are called shareholders as they hold shares in the company they own. A company is divided into shares (parts) and shares are certificates which provide a proof to the ownership of the company, partially or fully, depending upon the percentage of shares owned.
From business ownership viewpoint, there are mainly three types of businesses, Sole trader, Partnership, and limited company. Sole traders and partnerships are usually managed and run by the owners. However, in case of limited companies, this may not be the case. Limited companies are of two types, private limited (PVT) company, and public limited company (PLC). A private limited Company is mostly small in size which may also be called as “Close” and “Micro” company. In the case of close or micro companies, owners/shareholders would usually be the directors of the company and involved in the day-to-day operations of the business. By doing so they would be fully aware of the financial situation of the business. However, for some Private companies e.g., Boots and ASDA, and for most public limited companies, this is not the case.
These big businesses are run by the directors who are the top management of the company. These directors are hired by the shareholders to run the company on their behalf as owners are often not involved with business management of such big companies. Directors’ job is to work as shareholders’ agents protecting shareholders’ interest and work towards maximising their wealth. However, as it ever happens with human being, they could be tempted to work in their own interests even at the expense of the business and shareholders. Unfortunately, this happens a lot as research in this area suggests and the concept is called “Agency Problem”. Audited financial statements are a remedy to this problem.
Shareholders rely on financial statements to judge their agents i.e., director’s performance in running the company efficiently and increasing their wealth. Hence, financial statements are the only mean to the shareholders to know if their business is going in the right direction or not which is a significant stake.
Lenders
There are two main type of lenders for large businesses, Institutional Lenders and individual lenders.
Institutional Lenders
These are banks, pension funds and other large organisations dealing with lending of money. These lenders usually offer very large amounts of funds for which they require interest. However, in some cases, they also require policy changes in the business to protect their money. These institutions examine the financial statements thoroughly before offering loans and keep a close eye on the future performance by examining the financial statements on regular basis. It is important for companies to stay in their good books to avail future funding.
One important aspect of lending is overdraft facilities offered by the bank. These facilities can be withdrawn at any time if the bank think that business is in trouble. This is usually assessed by looking at the latest financial statements.
Individual Lenders
Besides taking loans from institutions, public limited companies also take loans in the form of loan notes and debentures. This type of financing resembles with share issue in many ways. Loan notes and debentures are certificates which lenders buy from the companies. These certificates confirm the amount lent, annual interest rate and redemption (buyback) date. This method of financing by the companies enables small lenders like individuals to buy loan notes as per their lending appetite. However, institutional investors are still the biggest purchasers of these certificates.
Suppliers
Around ninety percent of the world trade happens on credit and almost all of the businesses to businesses (B2B) trade happens on credited. As soon as a new business have developed a relationship with their supplier, they are usually granted credit purchases. However, suppliers would need to know the financial position of the business before allowing for such credit. Financial statements are the main document which is required with the credit approval applications. Suppliers assessed the business’s ability to pay back the money within agreed time. If the business become insolvent (out of cash), then the suppliers may not receive their money back.
Suppliers also keep a check on the financial health of their customer businesses as their sales depends on them. If a large customer goes out of the business, it can be problematic for the supplier as this effect the sales, production and procurement budgets. This would result in reduction of sales and profit as well as losses due to products going out of date. Anticipating problems with customer’s business can help better planning for raw material purchases and Labour too which will save money to the business.
Customers
Individual customers are generally not interested in the financial statements of a business. They could be more concern with the non-financial information given in the annual reports including Corporate Social Responsibility Report (CSR). CSR covers the impact of the business on the community around the business, planet and its environment, sustainability issues, etc.
However, for a business (B2B transactions), it is very important to keep a close eye on the financial statements of suppliers. This is especially the case when a supplier is the main source of the products which business is selling and/or the products can only be sourced from that supplier. In modern business world, where supply chains are global and complex, such suppliers are critical for the existence of the business as if the supplier is unable to supply goods in future, the business itself can go out of the business. A recent example is shortage of electronic chips in 2020 which has caused suspension of manufacturing in many sectors especially the electric cars sectors. The suppliers of electronic chip reduced production suspecting less demand due to Covid-19, however, increase in demand for personal computers as many people were working from home caused the shortage which wiped out billions of dollars from car manufacturing businesses’ market value (share price) in February -March 2020.
External Stakeholders
These are mainly parties in this area, prospective investors, government bodies and general public.
Investors
From management perspective, Investors are the most important users of the financial statements. These are the stakeholder who might invest in the business depending on the information given on the financial statements. Annual reports which contain financial statements are design to attract and invite investors to invest in the company’s shares on the stock market. More investment can make share price of the business go higher which often results in higher bonuses for the management which incentivise the management to highlight the information in the annual reports with appositive impact on the investors’ decisions to invest in the business and dress up the information which may not be perceived good.
Competitors
Competitors are the unwanted users of financial statements but they may be the one who use financial statements of a company most extensively. They analyse this information to assess the strategies being used by the business and opportunities to learn from those. Competitors would like to learn about the trade secrets of the business if they think the business is doing better then them. They would also like to keep a check on the pricing from their competitors to keep the competition. For manufacturing businesses, cost of producing an item can be a critical information for the competitors to assess the production processes being used. Better businesses are often able to produce the same product with less cost due to their advance processes. Other businesses would like to adopt the process if they know a better one exists.
This is the reason why financial statements do not give all the information which may be needed to analyse the performance of the business. Every business tries to give the bare minimum required by the law to protect their trade secrets. However, it is a double-edge sword as all businesses exploit the information given in the financial statements by their competitors.
Government
Government is interested in the financial statements of the businesses for various reasons including employment data, Gross Domestic Product (GDP) which is a general measure of growth in the economy and to collect taxes from businesses. Stock exchanges require companies to submit quarterly and annual financial and other reports to ensure investors are not mislead and cheated which can have a negative impact on the trust on the economic system. However, despite all the checks, there are many corporate scandals which has caused increased scrutiny by the government bodies into the operations of the public limited companies.
General Public
General public are generally not interested in the financial statements of a business. They could be more concern with the non-financial information given in the annual reports including Corporate Social Responsibility Report (CSR). CSR covers the impact of the business on the community around the business, planet and its environment, sustainability issues, etc.
However, researchers and students use this information to learn about accounting, business, and economy. A member of public can look at the financial statements to assess if the company could be a good employer and/or investment opportunity.
This article is written by Raja Mizan who is a senior lecturer in accounting & finance in a UK university. He is an ACCA member and also runs his own accountancy practice RMR Accountants & Business Advisors.