Financial Management - the Importance of Financial Information in Business

Activity 1

The Importance of financial information in business

Financial information is an integral requirement for the businesses which is considered as backbone of the business management. Companies are able to achieve their financial goals based on the available financial information. The information which is presented in meaningful form in financial terms is normally available in the Profit and Loss Statement, Cash Flows Statement and Balance Sheet.

Profit and Loss Statement shows the revenues and expenses accrued over a specific period of time. The Statement shows the profit or loss of the company. The financial ratios used to extract the analysis from the Profit and Loss Statement are Gross Profit Ratio, Net Profit Ratio, and Expenses to Sales Ratio etc. The ratios can be used to look for one period or to analyse the company performance in comparison to the previous period/s.

Balance Sheet shows the assets (current and non-current), liabilities (current and non-current) and Shareholder’s Equity of a company. It indicates the position of the company in terms of its liquidity and solvency. The ratios like Current ratio, Acid Test ratio, Debt Ratio, Interest Cover etc can be extracted from the Balance Sheet. The face of the balance sheet is the first snap of the company’s ability to survive for the foreseeable future based on its financial commitments appearing on the balance sheet.  

The Funds Flow or Cash Flow Statement is prepared and considered an important tool by the companies to have a quick look at the Cash worth of the business. For example, a company’s profit may be 20% of its Sales but the Cash realisation/inflows are far below 20% of sales. This puts the managers to dig the cause of the difference in the accounting profits and cash profits (cash inflows).

The financial indicators considered pretty important by the investors are the profitability ratios which are ofcourse linked to the absolute values of the Profit and loss Statement. Few are Earnings per Share, Dividend per Share, Price to Earnings Ratio etc

In short, financial information helps the Management to align their job descriptions and efforts towards the financial goals set by the organizations.

Business risks involved in the financial decisions

Having considered the financial information is available to the decision makers, still there are risks linked to the decisions. The decisions taken based on the financial information available sometimes go well and sometimes go wrong. The problem occurs normally when the Managers lack the business/market intelligence required to correctly interpret the financial information. For example, a company is willing to acquire another company which is considered worthy by the Managers however there may be some financial commitments linked to either the business of that company or due to the past obligations resulting in present obligations. The financial decision maker may ignore the serious legal implications resulting from the acquisition. The analysis of the financial information in light of all the aspects of the scenario is very critical to the decisions made since the decisions are made by the humans who are either good or bad at management skills.