Why Do Shareholders Need Financial Statements? (2024)

Financial statements provide a snapshot of a corporation's financial health at a particular point in time, giving insight into its performance, operations, cash flow, and overall conditions. Shareholders need financial statements to make informed decisions about their equity investments, especially when it comes time to vote on corporate matters.

There are a variety of tools shareholders have at their disposal to make these equity evaluations. In order to make better decisions, it is important for them to analyze their stocks using a variety of measurements, rather than just a few. Some of the metrics available include profitability ratios, liquidity ratios, debt ratios, efficiency ratios, and price ratios.

Key Takeaways

  • Financial statements provide a snapshot of a corporation's financial health, giving insight into its performance, operations, and cash flow.
  • Financial statements are essential since they provide information about a company's revenue, expenses, profitability, and debt.
  • Financial ratio analysis involves the evaluation of line items in financial statements to compare the results to previous periods and competitors.
  • Liquidity and solvency ratios provide information about a company's ability to repay its debts and obligations.
  • Valuation ratios help determine a fair value or price target for a company's shares.

Understanding the Need for Financial Statements

Financial statements are the financial records that show a company's business activity and financial performance.Companies are required to report their financial statements on a quarterly and annual basis by the U.S. Securities and Exchange Commission (SEC). The SEC monitors the markets and companies to ensure that everyone is playing by the same rules and that markets function efficiently. There are specific guidelines that are required by the SEC when issuing financial reports so that investors can analyze and compare one company with another easily.

Financial statements are important to investors because they can provide information about a company's revenue, expenses, profitability, debt load, and ability to meet its short-term and long-term financial obligations.There are three major financial statements.

Balance Sheet

The balance sheet shows a company's assets (what they own), liabilities (what they owe), and stockholders' equity (or ownership) at a given moment.

Income Statement

The income statement reports the revenue generated from sales, the operating expenses involved in creating that revenue as well as other costs, such as taxes and interest expense on any debt on the balance sheet. The net amount or the bottom line of the income statement is the net income or the profit for the period. Net income is revenue minus all of the costs of doing business.

Cash Flow Statement

The cash flow statement (CFS) measures the cash generated for a period, including all of the transactions added to or subtracted from cash. Cash flow is important because it shows how much cash is available to meet short-term obligations, invest in the company, or pay dividends to shareholders.

In addition to reviewing a company's financial statements themselves, also pay attention to the information provided in the footnotes to the financial statements.

Financial Ratios

Financial ratios help investors break down the enormous amount of financial data that are reported by companies. A ratio is merely a metric to help analyze the data and make useful comparisons with other companies and other reporting periods.

Financial ratio analysis analyzes specific financial line-items within a company's financial statements to provide insight as to how well the company is performing. Ratios determine profitability, a company's indebtedness, the effectiveness of management, and operational efficiency.

It's important to consider that the results from financial ratios are often interpreted differently by investors. Although financial ratio analysis provides insight into a company, individual ratios should be used in tandem with other metrics and evaluated against the overall economic backdrop. Below are some of the most common financial ratios that investors use to interpret a company's financial statements.

Profitability Ratios

Profitability ratios are a group of financial metrics that show how well a company generates earnings compared to its associated expenses. However, investors should take care not to make a general comparison. Instead, they will get a better sense of how well a company is doing by comparing ratios of a similar period. For example, comparing the fourth quarter of this year with the same quarter from last year will net a better result.

Return on Equity

Return on equity, or ROE, is a common profitability ratio used by many investors to calculate a company's ability to generate income from shareholders' equity or investments. Companies issue shares of stock to raise capital and use the money to invest in the company. Shareholders' equity is the amount that would be returned to shareholders if a company's assets were liquidated, and all debts werepaid off. The higher the return or ROE, the better the company's performance since it generated more money for each dollar of investment in the company.

​ReturnonEquity=AverageShareholders’Equity/NetIncome

Operating Margin

Operating profit margin evaluates the efficiency of a company's core financial performance. Operating income is the revenue generated from a company's core business operations. Although operating margin is the profit from core operations, it doesn't include expenses such as taxes and interest on debt.

As a result, operating margin provides insight as to how well a company's management is running the company since it excludes any earnings due to ancillary or exogenous events. For example, a company might sell an asset or a division and generate revenue, which would inflate earnings. Operating margin would exclude that sale. Ultimately, the operating profit is the portion of revenue that can be used to pay shareholders, creditors, and taxes.

Operating margin = operating earnings / revenue

Liquidity Ratios

Liquidity ratios help shareholders determine how well a company handles its cash flow and short-term debts without needing to raise any extra capital from external sources, such as a debt offering.

Current Ratio

The most commonly used liquidity ratio is the current ratio, which reflects current assets divided by liabilities, giving shareholders an idea of the company's efficiency in using short-term assets to cover short-term liabilities. Short-term assets would include cash and accounts receivables, which is money owed to the company by customers. Conversely, current liabilities would include inventory and accounts payables, which are short-term debts owed by the company to suppliers.

Higher current ratios are a good indication the company manages its short-term liabilities well and generates enough cash to run its operation smoothly. The current ratio generally measures if a company can pay its debts within a 12-month period. It can also be useful in providing shareholders with an idea of the ability a company possesses to generate cash when needed.

Current ratio = current assets / current liabilities

Other liquidity ratios include the quick ratio (also known as the acid test) and the operating cash flow ratio.

Debt Ratios

Debt ratios indicate a company’s debt situation and whether they can manage their outstanding debt as well as the debt servicing costs, such as interest. Debt includes borrowed funds from banks but also bonds issued by the company.

Bonds are purchased by investors where companies receive the money from the bonds upfront. When the bonds come due–called the maturity date–the company must pay back the amount borrowed. If a company has too many bonds coming due in a specific period or time of the year, there may not be enough cash being generated to pay the investors. In other words, it's important to know that a company can pay its interest due on its debts, but also it must be able to meet its bond maturity date obligations.

Debt-to-Equity Ratio

The debt-to-equity (D/E) ratio measures how much financial leverage a company has, which is calculated by dividing total liabilities by stockholders' equity. A high debt-to-equity ratio indicates a company has vigorously funded its growth with debt. However, it's important to compare the debt-to-equity ratios of companies within the same industry. Some industries are more debt-intensive since they need to buy equipment or expensive assets such as manufacturing companies. On the other hand, other industries might have little debt, such as software or marketing companies.

D/E = total liabilities / total equity

Interest-Coverage Ratio

The interest coverage ratio measures the ease with which a company handles interest on its outstanding debt. A lower interest coverage ratio is an indication the company is heavily burdened by debt expenses.

Interest coverage = EBIT / Interest expense

EBIT stands for earnings before income and taxes, and is also referred to as operating profit.

Efficiency Ratios

Efficiency ratios show how well companies manage assets and liabilities internally. They measure the short-term performance of a company and whether it can generate income using its assets.

Inventory Turnover

The inventory or asset turnover ratio reveals the number of times a company sells and replaces its inventory in a given period. The results from this ratio should be used in comparison to industry averages. Low inventory turnover ratio values indicate low sales and excessive inventory, and therefore, overstocking. High ratio values commonly indicate strong sales and good inventory management.

Inventory turnover = cost of goods sold / average inventories

Valuation Ratios

Price ratios focus specifically on a company's stock price and its perceived value in the market.

Price-to-earning (P/E)

The price/earnings (or P/E) ratio is an evaluation metric comparing the current share price of a company’s stock with its per-share earnings. Higher P/E values indicate investors expect continued future growth in earnings. However, a P/E that's too high could indicate that the stock price is too high relative to the earnings or profit being generated. Investors use the P/E ratio to evaluate whether the stock price is fairly valued, overvalued, or undervalued.

The P/E ratio is most helpful when compared to historical P/Es of the same company and companies within the same industry.

P/E = stock price / earnings per share

Trailing P/E uses a stock's historical earnings relative to its market price, while forward P/E uses earnings forecasts.

Dividend Yield

The dividend yield ratio shows the amount of dividends a company pays out yearly in relation to its share price. The dividend yield provides investors with the return on investment from dividends alone. Dividends are important because many investors, including retirees, look for investments that provide steady income. Dividend income can help offset, at least in part, losses that might occur from owning the stock. Essentially, the dividend yield ratio is a measurement of the amount of cash flow received for each dollar invested in equity.

Dividend yield = annual dividends per share / share price

Which Financial Statement Is Most Important to Shareholders?

No single financial statement is most important, since the balance sheet, income statement, and statement of cash flows all contain crucial pieces of information. Moreover, many ratios computed using fundamental analysis will draw pieces of data from places found on different statements. For instance, ROE uses information from both the income statement and balance sheet.

What Do Financial Statements Tell You?

A company's financial statements provide insights into a company's financial position, profitability, and growth potential. Taken together, financial statements allow analysts to conduct fundamental analysis to evaluate a stock's value and growth prospects. Financial statements also can signal red flags about financial instability or accounting improprieties.

Are All Shareholders Entitled to a Company’s Financial Statements?

Publicly traded companies are required by the SEC to release their financial statements for public consumption. Investors and non-investors alike are able to access these documents online and for free, from a company's own website or through the SEC's EDGAR database.

The Bottom Line

There is no one indicator that can adequately assess a company's financial position and potential growth. That is why financial statements are so important for shareholders and market analysts alike. These metrics (along with many others) can be calculated using the figures released by a company on its financial statements.

Why Do Shareholders Need Financial Statements? (2024)

FAQs

Why Do Shareholders Need Financial Statements? ›

Financial statements are important to investors because they can provide information about a company's revenue, expenses, profitability, debt load, and ability to meet its short-term and long-term financial obligations.

Why do shareholders need financial statements? ›

Financial statements allow investors to see all the income and expenses of a company. This, in turn, helps them determine their ability to generate profits and grow at a sustainable rate. A cash flow statement is a document that shows a company's ability to manage its income and expenses.

What is the importance of financial analysis to shareholders? ›

In essence, the importance of financial analysis cannot be overstated. By meticulously analyzing financial statements, stakeholders gain crucial insights into a company's financial health, guiding decisions on investments, credit, and strategy.

Why is accounting information important to shareholders? ›

Knowledge of accounting helps investors determine an assets' value, understand a company's financing sources, calculate profitability, and estimate risks embedded in a company's balance sheet.

Do shareholders have access to financial statements? ›

Closely Held Company Shareholder Rights to Records

Access to financial statements - Shareholders are entitled to review a company's financial statements, such as annual and quarterly income statements, balance sheets, cash flow statements, and stockholder equity statements.

Which financial statement is most important to shareholders? ›

Typically considered the most important of the financial statements, an income statement shows how much money a company made and spent over a specific period of time.

What are the financial statements of shareholders? ›

Stockholders Equity (also known as Shareholders Equity) is an account on a company's balance sheet that consists of share capital plus retained earnings. It also represents the residual value of assets minus liabilities.

Why are financial statements important? ›

The purpose of financial statements is to allow businesses to understand their financial standing. This provides a summary of previous financial data which can help businesses to make informed decisions. This data can also inform other individuals or companies which may potentially have a state in the business.

What is the purpose of the financial statements? ›

"The objective of financial statements is to provide information about the financial position, performance and changes in financial position of an enterprise that is useful to a wide range of users in making economic decisions." Financial statements should be understandable, relevant, reliable and comparable.

What are the benefits of financial ratios to shareholders? ›

Through the existence of financial ratios, the management and investors will greatly benefit. Because they can easily predict the company's future performance from the various data presented. This can help investors and potential investors to make better investment decisions and minimize financial risk.

How do financial statements help in decision making? ›

Creditors can make key decisions based on financial statements as these show the debt of the business and assets. Both long-term and short-term debts are outlined in the financial statements which show creditors how creditworthy your business is and they can base their decisions to lend to your business or not.

What is the main financial information required when providing information to shareholders? ›

Publicly traded companies are required to publish both quarterly (10Q) and annual (10K) documents to stockholders. These documents not only provide investors with the management's discussion of company events, but three financial statements including the income statement, balance sheet and cash flow statement.

What are 5 elements of financial statements? ›

The major elements of the financial statements (i.e., assets, liabilities, fund balance/net assets, revenues, expenditures, and expenses) are discussed below, including the proper accounting treatments and disclosure requirements.

Are shareholders financially responsible? ›

Shareholders are not personally liable for the debts of the company. The liability of a shareholder is limited only to any unpaid amount of their shares. The directors of the company control the company and its decision making.

What are the responsibilities of a shareholder? ›

The fundamental duty of a shareholder is to make decisions. A shareholder doesn't manage the day-to-day business of the company as this is handled by the board of directors.

Why is the annual report so important to investors? ›

The purpose of the annual report is to provide stakeholders, such as shareholders, investors, and employees, with a clear and concise overview of the company's performance and operations. It is also an important tool for communicating with these stakeholders and building trust and credibility with them.

What benefits does an accounting information system provide to stakeholders? ›

These are the following significant benefits from Accounting Information Systems;
  • Automation. An AIS eliminates the manual processing of data. ...
  • Accuracy. ...
  • Data Security. ...
  • Speed. ...
  • Cost-effective. ...
  • Functionality. ...
  • User-Friendly. ...
  • Scalability.
Oct 13, 2020

How accounting information is used by investors owners shareholders and other stakeholders? ›

Financial accounting provides transparency and access to information concerning the operations of a company. With standardized accounting practices according to GAAP, investors can compare the financial statements and performance of companies with those of their industry peers.

How does accounting affect stakeholders? ›

The management and employees make better decisions in the future by referring to old accounts and whether forecasts match actual accounts, Shareholders need to be assured that the resources they invested in the business are being used and managed well.

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