The purpose of financial statement is to provide reliable information about the financial position, results and relevant changes in financial performance of a company or business. Listed companies use financial statements as one of the major medium of communication with their equity shareholders and public at large.
When these financial statements are released, they can have large impacts on the business and on the investors of the company. Therefore, it is critical for the companies to ensure that the information the statements present is correct. Financial statements can have a drastic effect on the stock price of a company. Sophisticated investors look at the financial statements when making investment decisions though the ignorant ones do not. Hence, they are slaughtered.
Financial statements can also have an impact on how easy it is for a business to get financing. If a company is trying to take out a business loan, the lender will typically want to look at the financial statements of that company. Financial statements also have impact on new investors. When a company issues new shares of Stock, it will most likely distribute financial statements to potential investors. Low earnings numbers could negatively impact the number of investors willing to put money into the company. In some cases, financial statements can even affect other businesses. For example, a leading company in a particular industry releasing financial statements can influence that industry as a whole. This was witnessed recently in the Nigeria banking sector. Bank stocks started nose diving after First Bank Nigeria made a negative pre earnings announcement.
Shareholders of a company, both existing and potential, will want to know how effectively the Directors are performing their stewardship function. Investment decisions depend on expectations of the benefits of the investment, which in turn depend on expectations of future growth and product demand. Expectations of future growth are based on information that includes earnings per share, dividends per share, leverage, and liquidity. Thus, the financial Statements are considered very important to shareholders.
Some authors such as Ugwumba(2010), have however argued that in developing economies, shareholders of corporate Firms do not seem to pay particular attention to financial statements in their investment decisions but rather on other extraneous variables such as the frequency and regularity of dividend payment and market price per share . This poor valuation has made investor to constantly lose value at the altar of bad investment choices as companies who understand the empirical naivety of an average investor uses such to profit and remain in business. Some studies such as Auerbach and Hassett (2006, 2007) have even suggested that some companies go as far as borrowing to pay dividend creating what is known as “Dividend puzzle”.
Shareholders are said to be quite keen with respect to the regularity of their (cash) dividend and, therefore, would usually react if there is an outright omission of dividend payment, or an announcement of dividend cut. To this effect, companies whose focus is to maximize shareholders wealth see the knowledge of how dividend change relates to the value of the company as a very important issue.
The following points should be noted:
- Profitability is over emphasized in the market which makes some firms to ‘massage’(when management intentionally alters their result to meet market expectations rather than reality) their profit to suit investor’s expectation. When your investment decision is solely based on profitability, you might be on a long ride to disappointment.
- Investors are dividend driven. Companies can go to any length just to let them have it, even if it requires them borrowing to do so. This agrees with Gordon’s bird-in-hand argument. Therefore, when picking stocks, look beyond the dividend stories. you might consider companies with high earnings per Share as such companies might be building their quality over time for better future rewards
- Mind the leverage level of a company. Always check its liquidity ratios to ensure that it’s safe and sound for the taking. Blindly investing in excessively leveraged companies might be a good recipe for disaster.
- Don’t go to the stock market if you don’t know how to swim the tides of the market. Invest in your financial education and master how to read numbers and know to play the game big.
- You must also have a strategy that appeals to your reality. Don’t follow what friends and families are telling you. Losing money and sometimes your life in the frenzy and excitement of the stock market is real for any investor who doesn’t understand the game and how to play to win and not just playing not to lose.
You must be ready, study, test and master the process and insure yourself with good strategies that can help improve your results. Nothing can be sadder than investing your hard earned money with huge ignorance and watch it all vanish in smoke.
AuerBach, A. and K. Hassett (2006). Dividend, Taxes and Firm Valuation: New Evidence, American Economic Review, May, 119-123.
Auerbach, J. Hines, and J. Slemrod,eds., Taxing Corporate Income in the 21st Century, 93 -126.
Ugwumba (2010), Empirical Investigation of the Information Content of Financial Statement and the
Effect of Shareholders’ Investment Decisions, Unpublished student project submitted to the
Department of Accounting, CABFM, Michael Okpara University of Agriculture, Umudike.