ExpertStakeholders' needs
Learning outcomes
- Identify the users of financial statements and state and differentiate between their information needs.
Objective a: Identify the users of financial statements and state and differentiate between their information needs.
Financial statements are not created in a vacuum; they are designed to be read and used by various groups of people known as stakeholders. A stakeholder is any person or organization that has a legitimate interest in the activities and financial performance of a business. However, these different groups have vastly different priorities and, consequently, look for different information when they read an annual report. The primary users are investors (existing and potential shareholders). Investors provide the risk capital for the business. Their primary information need is assessing the risk and return of their investment. They look at profitability to see if they will receive dividends, and they look at growth trends to see if the value of their shares will increase. They need to know if management is acting as good stewards of their money.
Another critical group is lenders (such as banks and bondholders). Unlike investors, lenders do not share in the upside of massive profits; they only receive their fixed interest payments. Therefore, a lender's primary information need is assessing solvency and liquidity. They look at the financial statements to answer one question: "Will this company generate enough cash to pay back the interest and the principal loan amount on time?" They are highly focused on the company's assets (which could be used as security) and its cash flow. Suppliers (trade creditors) have a similar, but shorter-term focus. They provide goods on credit and want to know if the company has enough short-term liquidity to pay their invoices within 30 to 60 days.
Other users include employees, who look at financial statements to assess job security and the company's ability to pay wages and bonuses. The government (specifically tax authorities) uses the financial statements as a starting point to calculate the company's tax liability and to compile national economic statistics. Finally, customers may look at the financial statements of a company they rely on (e.g., a company providing a long-term software warranty) to ensure the business will survive long enough to honor its commitments. Consider OrbitX, a commercial spaceflight company. An equity investor in OrbitX is looking for massive future revenue growth from space tourism. The bank that lent OrbitX $500 million to build a launchpad is looking at the value of the launchpad as collateral and the current cash reserves to ensure the next interest payment is made.
Conflicting Needs
Stakeholder needs often conflict. An investor might want the company to take high risks to generate high profits (and high dividends). A lender, however, wants the company to take minimal risks to ensure the loan is safely repaid. Financial statements must provide a neutral, balanced view that caters to all these diverse needs without bias.
- 1
The Equity Investor's View
Venture Capitalist firm 'Alpha Funds' owns 20% of OrbitX. When the annual report is released, they immediately turn to the Statement of Profit or Loss. They want to see if revenue from satellite launches has increased by the projected 40%. They are looking for long-term capital growth and are willing to accept short-term losses if market share is growing.
- 2
The Commercial Bank's View
'Global Standard Bank' provided a $500 million loan to OrbitX. They ignore the revenue growth projections and turn straight to the Statement of Financial Position and Cash Flows. They want to see the total value of OrbitX's tangible assets (rockets, facilities) and ensure the company has enough cash on hand to meet the $25 million interest payment due next month. Their focus is purely on downside protection.
- 3
The Supplier's View
'Titanium Alloys Ltd' supplies the metal for the rockets on 60-day credit terms. They look at OrbitX's short-term assets (cash and receivables) compared to its short-term liabilities. They just want to know that OrbitX has enough liquid cash to pay the $5 million invoice due next week. They do not care about OrbitX's 10-year strategic plan.
By understanding who is reading the statements, we understand why the statements must contain a comprehensive mix of profitability, asset valuation, and cash flow data.
Which stakeholder group is primarily interested in the financial statements to assess whether a company can pay its short-term invoices within 30 to 60 days?
What is the primary information need of a commercial bank that has provided a 10-year loan to a business?
Why might the employees of a manufacturing company be interested in reading the company's financial statements?
Which of the following best describes the differing information needs of an equity investor versus a lender?