January 10th, 2018
Importance of Accurate Financial Statements to Investors
Potential investors are interested in reliable information about a firm in which they want to invest, which can ensure a favorable return for their investment. To assess a firm’s suitability, potential investors, for instance, make analysis of the financial statements, so as to compare its performance with that of others that they could be interested in, or assess the trend of its financial position over a period of time (Brigham & Ehrhardt, 2010, p.88). One way through which such financial analysis proceeds is via ratio analysis. Ratio analysis helps investors to predict future returns on their investment based on the past and present performance of the entity as portrayed by its financial statements (Brigham & Enrhardt, 2010).
One ratio through which investors could evaluate the suitability of a firm for investment purposes is the return on invested capital (ROIC). This ratio is provided by calculating the net operating profit after taxes (NOPAT) as a proportion of total operating capital (Brigham & Enrhardt, 2010, p. 66). Such a ratio would provide investors with information on whether the rate of growth meets their required rate. Another ratio that would be important to the investors is the return on equity (ROE), which is calculated as the proportion of net profit available to common stockholders with respect to the amount of common equity (Brigham & Enrhardt, 2010, p. 100). Such analyses are conducted by evaluating the values reported in audited financial statements. The importance of accurate financial statements in this respect would thus be to provide investors with credible and reliable information, upon which to base their analyses, thus help them make prudent investment decisions. Inaccurate statements, on the other hand, could result in investors making a faulty conclusion on the prudence of the investment in a specific firm, which could subsequently result into legal suits when they discover that such inaccuracies was a result of fraudulent practices. Go to part 3 here.