Understanding Financial Statements

Using financial statements, users can understand some fundamental elements on the performance of businesses and disposition and later deciding on the business grounded on the data from the statements. Due to the fact that financial statements are hugely depended on, they ought to be prepared in such a manner that they can be easily understandable and easy to understand. Normally, these notes explain every item in the balance sheet, income statement, and cash flow in a detailed manner. Such information on financial statements is usually considered to be integral when deciding on whether to invest in a company or not. Even as much the information on the financial statement is crucial, it tends to have various limitations that a user should be aware of before making a decision.

In this case, the essay, will assess the Eastman Kodak Company, as accompany that has gone through bankruptcy and limitations of using the financial statement of the company. Kodak majorly lost its competitive advantage in the market due to its constant decline in the share price, price competition, especially by Fuji, high debts, increasing liabilities verses insufficient total assets, bad governance and inefficient government structure. In terms of a company that had issues in the past, the article will at J. Crew group, that had debt issues.

Limitations of Financial Statement

In some instances, financial statements can be manipulated by unethical accountants and management to make the firm look more profitable than it is and attract more shareholders. The intentional manipulation of these figures take place are sometimes a product of cross-time or cross-company comparison challenges when diverse accounting frameworks are used to make the financial statements, and where there are inadequate records of a company’s economic prospects because of the focus on financial facets (Martínez‐Ferrero, Garcia‐Sanchez, and Cuadrado‐Ballesteros 2015). Besides, people are bound to interpret financial statements differently or misinterpret them all together. For example, in the case of J. Crew, the managers were able to secure more debts by manipulating the value of the company’s assets and revenue. However, in 2017, it was evident that the company could not incur the costs of its debts, which led to huge debt issues that the company was not able to settle. Therefore, if an investor was to use the 2015 financial statement to make an investment decision, there is a high probability that the investor would have been misled.

In most cases, financial statements are always based on historical costs; this is since business transactions are always recorded at their costs, in the long run, the values of assets and charges can be altered over time. In the balance sheet, some items like the vendible securities are always changed to match the existing market value, while other items like fixed values tend to remain constant (Cabedo and Tirado 2004, p.181). Therefore, the balance sheet can mislead one based on the sum offered, which is grounded on historical expenses — for instance, taking an assumption of an asset that was purchased at the start of a financial year at $10,000 as documented on the value indicated in the voice. As the year progresses the real market value of the assets reduces to $5000 because of other factors in the market. The balance sheet of the same company would document that the real asset value is $10,000. At the maximum limit, there could be some depreciation of about 15%. The net value after the market depreciation would less the indicated value on the balance sheet. Even so there is a huge variance between the balance sheet value and the market value of the same asset. Ultimately the reliance on historical costs renders financial statements less reliable and misleading. For example, in the case of Kodak, the company used historical accounts and the existing data to estimate the sale incentives at the time when revenue is collected (Kodak 2011, p. 23). In such a case, the historical accounts might not be accurate, because they are majorly based on estimations

The effects of inflation are another factor. In cases of inflation, the value associated with assets and liabilities in the financial statement is likely to appear lower because they are not usually assessed for inflation. In most instances, this is applied to long-standing assets (Fraser, Bhaumik, and Wright, 2015). For instance, if the cash in the last financial year was documented at $1,000, and the purchasing power of the dollar reduced by 10% in the economy, the cash in last year’s balance sheet will now be indicated as $1,111, while in real sense the sum of the cash $1,000. Therefore, the monetary items documented in the current balance sheet ought to be analysed to assess when they were obtained. Hence a fixed asset that has a previous cost of $1,000 in the current balance sheet, and which was obtained ten years ago when the purchasing power of the dollar was approximately 75% more than the current value, would be documented as $1,750. Such occurrences could be noted in both Kodak’s financial statement in 2010, and J.Crew’s financial statement of 2017

The intangible assets might not be sufficiently recorded. Most companies do not record intangible assets under the assets section; rather, any expenditure that is used to create an intangible asset is perceived as expenses. The policy can lead to drastic underestimation of the worth of a corporate, particularly if the business spent a large sum on building up the brand image or establish a new product in the market. It is even a bigger challenge when dealing with companies that are undergoing through a liquidation process and had created intellectual property but ultimately led to minimal sales.

Intangible assets are not physical, and therefore their market values are hugely debatable. As much as they might contribute to the company’s revenue, it is always not clear to what extent they have contributed to the success or failure of a company. Due to this reason, the value of intangible assets is always estimated. Therefore, when dealing with a liquidating company, this value can either be exaggerated to make the company look more stable and progressive or can be reduced to facilitate the process of liquidation. Birt (2019) argued that in most cases, the estimates given by analysts are rarely perfect. The only anticipation behind the earning season is to evaluate whether an entity can outperform or underperform earnings estimates. Even in the case where there is enough information on a company’s financial status, the state of the market (for example inflation), and the relevant industry, such estimates are still challenging to ascertain and justify.

The real value of the intangible assets in a company is not likely to be consistent over the years; this especially more visible when a company starts to fail. In most cases, lower sales rate implies that the customer's value of a brand is decreasing, or the company is losing its competitive advantage, and the brand value might be on the decrease, or the competitive value of a piece of intellectual property could be decreasing (Graham, Harvey, and Puri 2015, p. 449). As much as the value of the intangible assets might decrease in a balance sheet, they might affect essential metrics that rely on the shareholder’s shares or the assets, elements such as debt to equity ratio, and the price to book value ratio.

Lastly, in the case of liquidation, intangible assets are likely to be valueless. Therefore, the risk assumed could be much more in an entity that has lower net intangible assets. Although it could be more appropriate based on the investor’s strategy, the effects of low net tangible assets in the process of liquidation could be equally relevant to shareholders irrespective of the strategy. The value of intangible assets also affects all shareholders irrespective of the strategy, since it impacts on the attractiveness of equity in the market (Škoda and Bilka 2012). An entity that has recorded an increase or decrease in assets could render a stock more or less attractive, therefore pushing the stock price or reducing it. Hence, such an impact cannot be overlooked even if the potential investor does not focus on the value of an asset. In the case of Kodak in 2010, the asset management ratio revealed that the company is very stable, but on the other hand the company was not capable of meeting its payments because of its debt cage.

In terms of Net Profit ratios, for a prolonged time of more than five decades Kodak has been earning massive profits. However, in the last five years, the company only recorded profits in one year, and suffered losses in the remaining four years. From a cross analysis of the Kodaks, financial statements from 2007 to 2012, it is clear that that the company had minimal chances of making profits. However, if an investor only used the 2009 financial statement, when the company realized profit, they are likely to invest in the company, yet the company was on its way to bankruptcy.

Reference

Birt, J., Chalmers, K., Maloney, S., Brooks, A., Oliver, J. and Bond, D., 2019. Accounting: Business reporting for decision making. John Wiley & Sons.

Fraser, S., Bhaumik, S.K. and Wright, M., 2015. What do we know about entrepreneurial finance and its relationship with growth?. International Small Business Journal, 33(1), pp.70-88.

Graham, J.R., Harvey, C.R. and Puri, M., 2015. Capital allocation and delegation of decision-making authority within firms. Journal of Financial Economics, 115(3), pp.449-470.

Martínez‐Ferrero, J., Garcia‐Sanchez, I.M. and Cuadrado‐Ballesteros, B., 2015. Effect of financial reporting quality on sustainability information disclosure. Corporate Social Responsibility and Environmental Management, 22(1), pp.45-64.

Nowak, M., 2012. Advantages and disadvantages of auditor profession according to students of economics. Prace Naukowe Uniwersytetu Ekonomicznego we Wrocławiu, (263), pp.150-161.

Škoda, M. and Bilka, P., 2012. „Fair value in financial statements–advantages and disadvantages”. Studia Universitatis “Vasile Goldiş” Arad Seria Ştiinţe Economice, pp.1-8.

Kodak, (2011). Eastman Kodak Company 2010 Annual Report on Form 10-K and Notice of 2011 Annual Meeting and Proxy Statement.

Cabedo, J.D. and Tirado, J.M., 2004, June. The disclosure of risk in financial statements. In Accounting Forum (Vol. 28, No. 2, pp. 181-200). Taylor & Francis.

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