Why reformulate financial statements?
Brand X Pictures/Brand X Pictures/Getty Images
Reformulating financial statements means rewriting them to allow clearer examination of different aspects of the company's business. As a general principle, reformulation means presenting the same information, with the same totals, but breaking it down into different categories to those used in standard formats.
In many cases, a business will reformulate its financial statements to help demonstrate that its performance looks better when you look at it in a different context.
Most businesses follow standard procedures when producing their main financial statements. This is designed to allow a fairer and easier comparison of the performance of rival companies, and to allow potential investors to look at a document and immediately know the basis on which it was prepared. The problem is that using these procedures, known as reporting standards or financial standards, doesn't always make it easy to look at a specific aspect of the business.
Operating vs financial
A business might reformulate its income statement to show a clear distinction between its income and expenses that relate to the core business activity and those that relate to financing. Money spent on interest on loans would fall into the latter category. This could be relevant to a potential buyer who could settle the loan or get better financing. Splitting up the information this way makes it easier to show whether the day-to-day activity of the business is fundamentally profitable.
Cash vs cash equivalents
A business will often list a single category covering both cash and cash equivalents, the latter being assets that can be converted to cash without significant notice requirements or financial penalties. The business might reformulate its accounts to distinguish between literal cash (physical money and instant-access bank accounts) and cash equivalents. This could be relevant for a retail business such as a market stall that needs to show it can cope with the fluctuations in need for immediate access to physical money.
Recurring vs non-recurring
A business might reformulate its accounts to separate those transactions that are part of its regular activity (and can be expected to reoccur in the future) and those that are or are likely to be one-offs that might not reoccur. For example, the amount the business spent on rent is a reasonable guide to future expenses: if it's too high, the company's outlook appears bleak. On the other hand, a big loss caused by an unfavourable currency exchange rate change between taking an order from a foreign client and receiving payment is more likely a one-off; dealing with that client might be more profitable if exchange rates are more stable in future.
In some cases, most notably regulatory filings and tax returns, a business may legally be required to prepare and display financial statements in a particular manner. Reformulating in a way that contravenes these requirements can be a serious offense, particularly if the result is overstate or understate an aspect of business. A business is usually allowed to reformulate financial statements for its own analysis. If a business reformulates financial statements before showing them to a potential partner, buyer or investor, it will need to clearly state how the statements have been produced to avoid claims of misrepresentation.
Types of Management Accounting Information→
Importance of Investment Appraisal→
How to compare financial ratios to industry average→
Internal and external factors affecting share price→
Why stakeholders might be interested in the financial information of the organization→
What is an expenditure budget?→
- Brand X Pictures/Brand X Pictures/Getty Images