The Financial Statements as Tools for Planning and Control

Periodically created financial statements reflecting the historical economic transactions of the company can serve the organization and its shareholders through internal application and analysis of the data as well as through their general purpose of external reporting. Internal analysis of the financial data presented in the organization's financial statements differs from the analyses of external users, as the internal purposes are geared toward operational planning and controlling. Used externally, the financial statements provide the user with an overall view of the operational performance of the company. However, applied internally, more specific details can be added to the financial data to provide the managers specific performance and operational data that meets the informational needs associated with planning and controlling activities. The lack of regulation associated with using this economic data internally allows the organization to reorganize the data in such a way that provides essential, customized economic data that will assist in appropriately adjusting operational strategies to further the organization toward its goals. Reports and information that assist management with problem solving, improvement strategies, activity based management, added-value assessment, and analysis of the value chain can all be created using the balance sheet, income statement, statement of cash flows, and statement of owner's equity (CTU Online, 2008).

The financial position of a company is reflected in the balance sheet. The balance sheet provides a periodic view of the organization's assets, liabilities, and owner's equity (Horngren, Harrison, & Bamber, 2005). Inventory accounts represented on the balance sheet include three separate inventory classifications: raw materials, work in process, and finished goods (Garrison, Noreen, & Brewer, 2008). The information included in the balance sheet, including specific inventory classifications, can be broken down to more specific products, asset categories, business divisions, even specific equipment categories and processes to provide greater insight into performance and progress of the many different operational areas (CTU Online, 2008).

The income statement reflects the revenues and expenses incurred from operations over a specific period of time, communicating the resulting profit or loss (SMBTN, 2007). Used internally, income statements can provide performance information relative to specific products, product lines, processes, or divisions within the company (CTU Online, 2008). Cost structure is essential to profitability, therefore specific cost information is imperative to appropriate operations planning. Restructuring and reassigning costs by their behavioral patterns creates a contribution margin income statement. The contribution margin income statement represents the resources remaining to cover fixed expenses after variable expenses are accounted for (Edmonds, Edmonds, Tsay, & Olds, 2006). The benefit of reclassification and reorganization of costs to management, as they plan for future periods and work to control costs and increase profitability, is that it provides profitability information as it relates to the different processes and products. This facilitates more informed and intelligent decision-making regarding pricing, price adjustments, product line development and elimination of products or processes that are unprofitable and drain on resources created by more profitable products and processes.

Incoming cash receipts and outgoing cash payments are reported in the statement of cash flows. Fluctuations in cash during the reporting period are evident in the cash flow statement. Inflows and outflows are classified into three specific business activities: operating, investing, and financing activities. Operating activities will generate revenues, associated expenses, and any gains or losses, directly influencing the net income as provided from the income statement. Current assets and liabilities are also directly influenced by operating activities, further impacting the company's balance sheet. Long term assets are increased and decreased through investment activities, and all purchases and sales relative to long term assets, as well as loans to others and collections on loans, are reported as investment activities on the cash flow report for the period. Obtaining cash for launching or funding continuing operations for the business are classified as financing activities. Issuance of stock, borrowing money from a bank or other lender, the purchase and sell of treasury stock, and paying dividends to shareholders are all considered financing activities and are reported as such on the statement of cash flows. When analyzing the statement of cash flows, it is generally a good sign for long-term success if the majority of the cash flows associated with business activity are generated through operating activities. If the majority of the cash flow is generated through financing activities, that should represent only a short-term situation, as financing should not persist and investors will begin to demand a return. If the organization's reported investing activities make up the majority of cash flows for any given period, that is typically interpreted as a bad sign, as it could signal business troubles through sales of long-term assets (Horngren, et al.). Understanding how to correctly classify and analyze operational inflows and outflows will assist management in spotting problem areas and restructuring to maximize on organizational potential.

All changes occurring within a specific reporting period are shown on the statement of owner's equity. Equity increases from investment and income, and decreases from withdrawals and losses as they relate to the owners or shareholders of the company and are communicated in this financial statement (Horngren, et al.). Information relative to the income or increase in value as experienced on the ownership level is essential to ensuring future funding and investment opportunity.

The different financial statements discussed are used together and separately in numerous ways to assist management in planning and controlling future operations as the specific data resulting from analysis provides the information needed to make the operational changes required for improved overall organizational efficacy. Financial statement analysis as applied to managerial accounting practices will focus on horizontal analysis, vertical analysis, and ratio analysis (CTU Online, 2008).

Horizontal, or trend analysis, is the analysis of the data for a specific financial statement item as reported over a period of time, showing year to year or quarterly changes in terms of dollars or percentage of change. Trend percentages can be calculated when multiple periods are reviewed and compared against the chosen base year (Garrison, et al.). Both the dollar changes and percentage changes associated with the specific areas of analysis on the financial statements must be given consideration as to not allow one of the results to be given unearned significance (Winicur, 1993). For instance, a specific dollar amount may not be correctly judged in its significance when not viewed in relation to actual percentage of change. Realizing the trends associated with the specific focus of analysis assists in setting more realistic goals for the future and preparing a budget that more closely reflects the most likely scenario for operational performance. Proper planning and budgeting, as produced through horizontal analysis, will ensure that all necessary resources are available to meet the anticipated demands of the organization.

Vertical financial statement analysis focuses on the relationships of the many different elements within the financial statement for a single reporting period. Vertical analysis produces a percentage representative of the portion of the individual items or activities as they relate to a larger, or overall item, activity, or view of the statement. Vertical analysis of an income statement might reflect the total percentage of sales associated with individual corporate divisions or products. Likewise, those items could be shown as a percentage relative to the total costs, or compared to other product costs for the period. Sales are often compared against a benchmark percentage taken from specific industry data, helping to assess organizational performance and compare actual progress with budgeted or anticipated progress. Vertical analysis of the balance sheet would convey items in terms of their percentage of total assets or total liabilities. This information is often used to compare organizational performance to industry averages and against anticipated goals. Managers and/or analysts also use vertical analysis to construct common-size financial statements, standardizing the financial information by giving it a common base or common perspective. Common size statements provide the user with a greater understanding of relationships among the many different elements of the financial statement such as sales and expenses, assets and equities, or cash flows and changes in cash, further facilitating wise decisions as all dependent factors are considered (Plewa & Friedlob, 2002).

Results from both horizontal and vertical analysis are employed to create pro-forma financial statements and budgets for use within the organization. The evident trends and interdependent relationships help management create financial statements reflecting anticipated performance for future operating periods. Also known as the projected income statement, or projected balance sheet, these statements communicate to management the anticipated production and operational needs of the organization that they might appropriately secure and allocate all necessary resources, human, financial, material or otherwise (Atkinson, et al.). Financing must be secured, cash must be available for inventory purchases and all payments, and all goals and expectations must be well communicated to everyone in the organization to provide a point of reference for future operational decision-making activities (Edmonds, et al.). Pro forma statements and budgets will also reflect the impact of intended process or product changes within the company, providing users and planners with a view of how these changes will directly affect the financial reports once implemented. The ability to analyze these potential changes further serves management in the decision making process as the value-added principle is applied. The master budget and all divisional budgets will convey goals and expectations for operational efficacy within the different departments of the organization and provide a means of measure by which to gauge progress and performance.

Although ratio analysis is more commonly used by investors or other external decision makers with a potential stake in operations and performance, management within the organization will want to know how well they are performing and how they are viewed externally. Understanding organizational performance as it is viewed by others provides management with information relative to the desired level of performance in all areas in which the company might be evaluated. Problem areas are recognized through understanding this performance, providing opportunity to correct these areas and present the company as a more desirable investment opportunity (CTU Online, 2008). Countless ratios are applied to the data on the financial statements to determine profitability, operational efficiency, financial leverage, liquidity, asset use, and market value (Atkinson, Kaplan, & Young, 2005). Financial ratios provide specific numeric values or percentage values that answer questions related to the organization's ability to repay debts, how quickly finished inventory is sold, or how much each shareholder has earned over the purchase price of their stock. It is obvious that specific information such as this will be needed by those judging the organization's potential for success, and easily understood that knowledge of these specific elements within the organization provide us with financial performance targets.

From appropriate pricing and product selection practices, through projecting operational expectations, the role of financial statements and their inclusive data is evident in successful completion of the many responsibilities of the manager and the continual success of the organization. Planning a strategy for success and procuring all necessary resources to attain organizational objectives, and having the specific cost information for products and processes allowing managers to better control operational activities and achieve optimal efficiency are significant elements in the organization's efforts toward continual improvement and increasing value and stability.

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