Essay About Users Of Financial Reports And Financial Statements

What Do Users Of Financial Reports Want
Essay Preview: What Do Users Of Financial Reports Want
Report this essay
Purpose
This Executive Report summarizes a series of interviews with preparers of financial
statements and commercial and investment bankers that sought to answer the
question, what do users of private company financial statements want? It has been
prepared with Financial Executives International’s Committee on Private Companies
for FEI members and others and has been sponsored by the NFIB Research
Foundation.
Executive Summary
The following themes emerged from the interviews:
Internal Management
• Internal managers receive financial and operating information for their businesses.
• This information is not in the format of full-disclosure, financial statements prepared
according to generally accepted accounting principles (GAAP).
• Operating information is provided on both a weekly and a monthly basis.
Bankers
• Banks want annual audited GAAP financial statements for accuracy and
comparability, and they also want quarterly financial statements.
• Other financial information that may be provided includes:
o Detailed aged payables, receivables and inventory.
o Monthly loan covenant calculations (debt to tangible net worth and current
ratio calculations).
o Collateral reports, and
o Quarterly cash flow coverage information.
• Data from financial statements are entered into computer models and databases to
measure liquidity and monitor compliance with debt covenants.
Investment Bankers
• Want audited annual GAAP financial statements for accuracy and comparability.
• Want supplemental information beyond GAAP, such as a history of capital
expenditures.
• A fair value appraisal will be required if a company is not liquid. This is not necessary
for a financially strong company.
Investors
• Want more information than is provided by financials prepared in accordance with
GAAP.
• Are more interested in operating data than financial data.
• Consider trend lines and year-over-year comparisons to be important.
Use of GAAP
• GAAP does not provide the detail needed by investors or even banks.
• Certain calculations are difficult and time consuming (Ex. FIN 46).
4 | Financial Executives Research Foundation
Debt Covenants
• Debt covenants are not always standardized and are often based on the borrower’s
industry.
• Financial information required by debt covenants includes cash earnings (earnings
before interest, taxes, depreciation, and amortization or EBITDA), cash flow and
tangible net worth, which excludes non-cash intangible assets such as goodwill.
• EBITDA, as a proxy for cash earnings, is very important to banks. Financial
statements should segregate depreciation and amortization so that they can be added
back to net income to calculate EBITDA.
• Some debt covenants may include maintaining certain ratios:
o Leverage: total liabilities divided by tangible net worth should be less than
three to one; and
o Earnings or cash flow: funded debt divided by EBITDA should be less than
three to one.
• Debt covenants may require that the company maintain a minimum targeted tangible
net worth and maintain a ratio of debt to tangible net worth that is less than a targeted
percentage, again depending on the industry.
• Banks may also require that borrowers maintain a minimum debt service coverage,
often defined as the ratio of net income plus non-cash charges to current maturities of
long-term debt plus interest.
Internal Controls
• The only users that have requested compliance with Sarbanes-Oxley are investment
bankers, in anticipation of a sale of a company or an initial public offering (IPO).
Financial Executives Research Foundation | 5
Introduction
Most financial executives would agree that serving the needs of the users of financial
statements is one of the primary objectives of financial reporting. Broadly speaking, users of
financial statements can be categorized as internal and external. Internal users include
company management, owners and directors. External users can be further categorized into
two groups:
1. Commercial and investment bankers, insurance companies, leasing companies, vendors
and suppliers who