Accounting for Managers: Interpreting Accounting Information for Decision Making, 4th Edition

Chapter 7

Interpreting Financial Statements

This chapter begins with an overview of a company’s Annual Report and shows how ratio analysis can be used to interpret financial statements. This interpretation covers profitability, liquidity (cash flow), gearing (borrowings), activity/efficiency and shareholder return. We also look at working capital management in detail. Two case studies demonstrate how ratios can be used to look ‘behind the numbers’ contained in financial statements. The chapter concludes with several alternative theoretical perspectives on financial reporting including corporate social and environmental reporting.

Annual Reports

For all companies, the Companies Act requires the preparation of financial statements. Financial statements are an important part of a company’s Annual Report, which must be available to all shareholders for all companies listed on the Stock Exchange.

The Annual Report for a listed company typically contains:

• A financial summary – the key financial information.
• A list of the main advisers to the company: legal advisers, bankers, auditors and so on.
• The chairman’s, directors’ and/or chief financial officer’s report(s). These reports provide a useful summary of the key factors affecting the company’s performance over the past year and its prospects for the future. It is important to read this information as it provides a background to the financial statements, and the company’s products and major market segments (much of this information ...