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3. Basic financial reports and concepts

Understanding financial statements, concepts and conventions is a necessity if we are to know where we are, how we got there, and as a base for projecting where we might be. Financial statements can be used as a base for controlling strategies.

A prime aim of the book and specifically this chapter is to help you understand the principal financial statements - the statement of financial position (the balance sheet) and income statement (P&L account) - as the tools they are. The laudable aim of US and international accounting standards is that the statements are to be useful in making economic decisions. Here is the introduction to the IASB (International Accounting Standards Board) Conceptual Framework:

It (the IASB Board) believes that further harmonization can best be pursued by focusing on financial statements that are prepared for the purpose of providing information that is useful in making economic decisions. The Board believes that financial statements prepared for this purpose meet the common needs of most users. This is because nearly all users are making economic decisions, for example:

(a) to decide when to buy, hold or sell an equity investment.

(b) to assess the stewardship or accountability of management.

(c) to assess the ability of the entity to pay and provide other benefits to its employees.

(d) to assess the security for amounts lent to the entity.

(e) to determine taxation policies.

(f) to determine distributable profits and dividends.

(g) to prepare and use national income statistics.

(h) to regulate the activities of entities.

(IASB, 2013)

Other papers emanating from the standard setters have said that financial statements are to be 'decision useful', a lucid, though inelegant, phrase.

Financial statements and financial accounting can be dismissed as history. The statement 'Financial accountants count the dead', as a management accountant once said to me in my role as a financial accountant, may have some truth in it, but knowing where you are, the assets and liabilities under your command, is an essential starting point for any strategy.

An executive has many roles to play, depending on the size of the business, whether it is growing or not, the industry sector and so on. There are also fiduciary duties with respect to the company. Thus executives must know where they stand, the balance sheet, what assets they have custody of, what liabilities have been or will be incurred. They must comprehend their balance sheet and all it contains. Executives must understand past performance and learn from it, that is, performance as identified by sales and costs set out in the P&L account. They must also understand the business's cash flows, and this is considered in Chapter 8.

Accounting and financial reports support us in understanding and quantifying our position and results; a very valuable use is to confirm our understanding. However, it is important that readers come to this book with the clear understanding that they should know what is going on - having to wait for monthly or annual accounts suggests that you may not know your business.

It is not unreasonable to say that you should be able to run a straightforward business without accounts. But accounts exist:

- because law, tax authorities, regulators etc demand them - necessary but not positive reasons;

- as accounts are invaluable in affirming where you are;

- to give you a second chance - spot the issues you have missed;

- as a focus with unemotional numbers - showing where you are - or may be heading!

How can strategic decisions be made if you don't know where you are and how you got there? The strategic importance of cash is considered further in Chapter 8.

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