Why are accurate financial statements important for outside business interests? Free Essay Example

The business’ obligation to maintain accurate financial statements is inevitable not only for efficient management but also for the maintenance of a good corporate image essential for outside business interests. Financial statements represent the business’ position; information that is vital to all users of financial statements and other stakeholders. Any business is bound to have interests outside the business since it needs external support in order to thrive. Again, maintaining a proper image on the external environment helps the business to maintain goodwill and to increase investor confidence.

Inaccurate financial statements discovered by government auditors or other interested parties could therefore lead to deleterious effects on the business. This is because these could be seen as dishonesty or fraud attempts on the part of the business even if the mistakes were not intentional. Financial statements should also aim at showing the business worth in the most accurate manner. The balance sheets, income statements, cash-flow statements, shareholder equity statements and any required supplementary data should therefore be as accurate as possible to eliminate such possibilities.

The statements should also be prepared according to the generally accepted accounting standards. This paper will discuss the importance of accurate statements for the business outside interests while showing the consequences of inaccuracy of the same. Discussion The business is not restricted to the internal environment only and it is expected that the interests outside the business are bound to influence its activities. Weber, Roth and Wittich (1987) define outside interests as those that the business does not consider as oriented towards its overall long-run profitability.

Instead, they influence the enterprise in one way or another and their interests could be vital to the business success (Pinson and Jinnett, 2006). This means that there is a wide degree of control over business policies by factors outside the enterprise. Outside business interests can be classified by virtue of market power or power over credit as in the case of banks and other financial institutions (Weber, Roth and Wittich, 1978). These organizations pursue different interests from those of the business yet there is need to incorporate their interests in the business so as to elevate the chances of obtaining credit.

The government as a regulatory body also counts as an outside interest (Fridson and Alvarez, 2002). Another external influence is the separation of appropriated ownership from managerial functions. Investors and shareholders also influence the business management and these could include speculative outside interests that are only likely to seek gains through resale of shares. The fact that outside interests could highly affect business mode of control requires that the business be careful with the decisions taken so as to incorporate these interests.

Having accurate financial statements plays a major role in this obligation. As the next session of the paper will indicate, this could highly impact on the business’ success. The government/Tax authorities Accuracy in financial statements makes business procedures while calculating tax returns easy. This is because there the income and expenditure elements can clearly be identified to come up with the right amounts of tax (Pinson and Jinnett, 2006). They also help in avoiding friction with the tax authorities if audit reports reveal that the tax returns were inaccurate.

Tax authorities use financial statements to check business adherence to tax laws (Fridson and Alvarez, 2002). While inaccurate statements could be a mistake on the side of the business’ accounting department or internal auditing department, it could culminate to undesirable effects for the business. The government through the tax authorities constantly performs audits to check whether businesses are making the right tax returns in relation to their annual income.

Negative results could mean trouble in the form of court cases and huge fines all which would have detrimental effects on the business (Fridson and Alvarez, 2002). The fines paid could have been used in other areas of the business so as to improve its profitability. Using this income to pay fines however is not an optimal way of spending finances hence the need to maintain proper financial records. Further, it is possible for legal tussles with tax authorities to shun the image of the business both in the eyes of the public and that of the stakeholders interested in the business performance.

It could strain the business borrowing capacity as banks could lose confidence in the organization. Given this kind of mis-happening, it is only essential that businesses maintain accurate financial statements. It must be noted that even though the tax returns can be amended after realization of a mistake in the financial statements, they only serve to increase the chances of the company being subjected to further audits (Pinson and Jinnett, 2006). This is because curiosity of the tax authority officials is aroused when constant mistakes are noticed.

The results of inaccurate financial statements could lead to unpleasant encounters with tax authorities as displayed in the case of Dressers Inc headquartered in Dallas in 2001. The company’s auditing department had failed to notice wrongful information in the form of financial statements error (Fridson and Alvarez, 2002). Company income had been understated through wrongful recording of information from income received by the company. An Internal Revenue Service audit revealed this error from comparisons made with original receipts.

As a result, the company had to pay fines for supposedly defrauding the IRS even though this was not the company’s intention. This just goes on to show the seriousness and importance of keeping accurate records. Banks and other financial institutions Only a few businesses can operate without the need for occasional financial boosts from financial organizations. Being in a position to obtain credit is therefore imperative to any business. So as to get access to credit, a business must prove its credit worthiness to the financial provider.

The most appropriate and convenient way even before the bank can start looking at the business assets is to examine the financial statements. As a result, these statements should be as accurate as possible. Banks are keen to look for statements that appear professional and which follow the acceptable accounting standards (Fridson and Alvarez, 2002). They should highlight key information out-ruling any compromise in quality. Such statements improve credibility and the company image so that the banks and other financial institutions are more willing to lend to the business.

Weber, Roth and Wittich (1978) note that the more confidence that these organizations have in the business, the more easier it becomes for the business to obtain credit and the business is at a better position to attract better terms and conditions in the credit agreements. Proper valuation of the business following accurate preparation of financial statements gives the true worth of the business. An accurate picture of the company worth is important because it reflects the financial power of the business and hence its credit worthiness (Pinson and Jinnett, 2006).

If the statements are inaccurate, valuation of the business by the banks could reflect a value below the business worth such that the amount of credit that the business can receive is limited. Financial institutions take particular interest in the method used by the business to record transactions. The accrual method is usually preferred to the cash accounting method due to the high possibilities of errors when the cash method is used. Kaufman (2009) notes that the utilization of cash-basis reporting has caused errors in over 90 percent of businesses that used it.

The cash method records cash from sales once it is received and accounts this as income in the financial record (Kaufman, 2009; Fridson and Alvarez, 2002). This is the opposite of accrual method that records sales as soon as they are executed even though no payment has been made (Fridson and Alvarez, 2002). It is said to be more accurate in showing the position of the business at any particular time. This is a call to businesses to make use of accrual accounting method rather than the cash basis if they are to seek funds from financial institutions. Investors/shareholders

Whether the investors hold a company’s shares for long-term investment purposes or speculative purposes makes little difference when it comes to the command that they influence on a company. Investors need financial statements of a company in order to determine whether the company’s shares are worth investing in (Fridson and Alvarez, 2002). They also use financial statements to gauge the profitability of the business and hence predict the probable position in future. The business needs to keep satisfying these investors so that confidence is enhanced and other potential investors are attracted to the business.

Accurate financial requirements are therefore absolutely essential for the business to maintain these investors (Fridson and Alvarez, 2002). There are two ways in which accurate financial statements assist in ensuring proper functioning of any business. The first one is in proper management leading to higher profits so that investors are more willing to invest in the company. The other one is in creating a good public image that can attract new investors and keep confidence of the existing ones. Management Kaufman (2009) notes that proper accounting practices are a tool to better management.

A business with accurate financial statements can easily establish the position of the business and make accurate decisions on the way forward so as to increase their profitability (Pinsonn and Jinnett, 2006). Due to the fact that the business assets and liabilities can be easily compared with incomes and expenses helps the business compare its position with other similar businesses. This way, averages can be compared to determine the strong and weak areas of the business operations and consequently take appropriate measures. This way, profits will be enhanced and therefore investors will be pleased with the company’s performance.

Improved corporate image If the business publishes accurate financial statements such that there is no need for correction later or cases where auditors discover wrongly prepared statements, investors’ confidence is maintained (Fridson and Alvarez, 2002). When the opposite happens however, investors lose confidence in the company and they are likely to avoid investing in the company shares. The notion behind this is that if the business cannot maintain proper financial records, the management function is flawed and the business is likely to collapse at any time.

Inaccurate financial statements are more likely to have a higher influence on speculative investors who are mostly interested in gaining profits (Weber, Roth and Wittich, 1978). These kinds of investors require that the shares they buy have the potential to increase in price in future. Accurate financial statements make the position of the business clear hence satisfy their concerns. Owners Separation of management from ownership is considered as an outside interest (Weber, Roth and Wittich, 1978).

This could depict the control of owners over the management such that the owners could find the need to replace managers depending on the performance of the business. As a result of this relationship, owners devise ways to check the efficiency of the managers. Financial statements are one way of assessing efficiency and one requirement that these statements be accurate. Should they be inaccurate after external audits are performed, owners may deem that the management is not working as expected or suspect fraud which is likely to lead to such errors (Fridson and Alvarez, 2002).

Other indicators such as the share of dividends for example could influence the decisions made by owners. If shareholders who are considered the owners of a company suggest that the dividends are not as expected due to poor management, present managers could be replaced. Dividends are to a large extent influenced by how profitable the company is. As noted earlier, accuracy in preparation of financial information could aid the management in planning hence influence the level of profit. Owner concern over accuracy of financial statements is what the business should aim at satisfying. Conclusion

Outside business interests play an important role in business policy decisions because they influence the company in various degrees. Businesses need to maintain accurate financial statements because they serve different functions to the outside business interests all which affect the business functions. Accurate financial statements not only show the current position of the business but are also important to other stakeholders who may base their decisions on them. There are four main outside interests in any business. These include the government in the form of tax authorities, financial institutions, investors and the owners.

The government needs to see accurate financial statements because then they are assured that the company is paying all the tax due from them. Banks and other financial institutions require businesses to present accurate financial statements because it is based on these statements that the credit can be offered to the business. Accuracy makes sure that the true worth of the business can be determined. The use of accrual basis of accounting is encouraged by banks for accuracy. Investors need financial information which is very vital in their investment decision making process.

They would require accurate information because they are interested in making profits and the contents of the financial profits dictate whether a certain company is worth investing in. Lastly, owners highly rely on financial statements to know the financial position of their business. Accuracy is therefore vital and inaccuracy could lead to changes being made in the management. All these findings reflect the importance of accurate financial statements and why the management should be very keen in ensuring that they are well prepared at all times. Word Count: 2234 References Fridson, M. S. ; Alvarez, F. (2002).

Financial statement analysis: a practitioner’s guide. New York: John Wiley and Sons, 2002 Kaufman, K. (2009). Your Month is Not Over Until You Have Accurate Financial Statements. Retrieved on July 6, 2009 from http://ezinearticles. com/? Your-Month-is- Not-Over-Until-You-Have-Accurate-Financial-Statements&id=1782046 Pinson, L. & Jinnett, J. (2006). Steps to business start-up: everything you need to know to turn your idea into a successful business. New York: Kaplan Publishing. Weber, M. , Roth, G. , & Wittich, C. (1978). Economy and society: an outline of interpretive sociology. US: University of California Press.