other tools for financial control

7/28/2019 Other Tools for Financial Control

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Other Tools for Financial ControlAlthough budgets are the most common means of financial control, other useful tools arefinancial statements. ratio analysis, and financial audits.

Financial Statements

A financial statement is aprofile of some aspect of an organizations financial circumstances.There are commonly accepted and required ways that financial statements must be prepared andpresented. The two most basic financial statements prepared and used by virtually allorganizations are a balance sheet and an income statement.The balance sheetlists the assets and liabilities of the organization at a specific point in time,usually the last day of an organizations fiscal year. For example. the balance sheet maysummarize the financial condition of an organization on December 31, 2008. Most balancesheets are divided into current assets (assets that are relatively liquid, or easily convertible intocash), fixed assets (assets that are longer term in nature and less liquid), current liabilities (debts

and other obligations that must be paid In the near future). long-term liabilities (payable over anextended period of time), and stockholders equity (the owners claim against the assets.Whereas the balance sheet reflects a snapshot profile of an organizations financial position at asingle point in time, the income statementsummarizes financial performance over a period oftime, usually one year. For example, the income statement might he for the period January I.2008, through December 31, 2008. The income statement summarizes the firms revenues less itsexpenses to report net income (profit or loss) for the period. Information from the balance sheetand income statement is used in computing important financial ratios.

Ratio AnalysisFinancial ratios compare different elements of a balance sheet or income statement toone another. Ratio analysis is the calculation of one or more financial ratios to assess some aspect of the

financial health of an organization. Organizations use a variety of different financial ratios as part of

financial control. For example. liquidity ratios indicate how liquid an organizations assets are. Debt ratios

reflect ability to meet long-term financial obligations. Return ratios show managers and Investors how

much return the organization is generating relative to its assets. Coverage ratios help estimate the

organizations ability to cover interest expenses on borrowed capital. Operating ratios Indicate the

effectiveness of specific functional areas rather than of the total organization. Walt Disney is an example

of a company that relies heavily on financial ratios to keep its financial operations on track

Financial Audits

Audits are independent appraak of an organizations accoumI ng. financial, and operational s ems. lhr iwo

major types of financial audits are the external audit and the Internal audit.External audits are financial appraisals conducted by experts who are not employees of the organtzation.-- External audits are typically concerned with determ ining that the organizations accounting proceduresand financial statements are coml)dcd in an objective and verifiable fashion. The organization contractswith a certified PUbIK accountant (CPA) for this service. 1 he CPAs riiain objective is to verif forstockholders, the IItS. and other interested parties that the methods by which the organizations financialmanagers and accountants prepare documents and reports are legal and proper. External audits are soimportant that publicly held corporations are required by law to have external audits regularly, asassurance to investors that the finant a1 reports are reliable.


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Unfortunately, flaws in tlw auditing process played a major role in the downfall of Enron and severalother major firms. The problem can be traced back partially to the auditing groups problems withconflicts of interest and eventual loss of objcct ivity. I-or instance, Enron was such an important clnt forits auditing firm, Arthur Andersen, that the auditors started kiting the firm take liberties with itsaccounting systems for fear (hat if they were too strict, Enron might take Its business to another auditingfirm. In the aftermath of the resulting scandal, ArthurAndersen was forced to close its doors, Enron is a

shell of its former self. indictments continue to be handed down, and the accounting profession is beingredefiiwd.3

Some organizations are also starting to employ external auditors to reviewother aspects of their financial operations. For example. some auditing firms nowsprciahzr in checking corporate legal bills. An auditor for the lireinans Fundlniiraiice Company uncovered several thousands of dollars in legal Ice errors.

Other auditors are beginning to specialize in real estate, employerbenefits, andpensionplan investments.Whereas external audits are conductedby external accountants, an internal auditis handled by emploecs of the organization. hs obfriivr is the same

as that ofan external audit-

to verify the accuracy offinancial and accountingprocedures used by the organization. Internal audits also examine the efficiencyand appropriateness oflinancial and accounting procedures. Because the staffmembers who conduct them are a permanentpart of the organization. iniernalaudits tend to be more expensive than external audits. lut employees, who are morefamiliar with the organizationspractkes. ma also focus on significant aspects

of the accounting system besides Its technical correctness. large organizations like llillihurton and lord have aninternal auditing staff that spends all its time conducting aLitlils of different dlv isIo,ls and functional areas of the

organliatrnn. Smaller organliations may assign accountants to an internal audit gniup on a temporary orrotatingbasis.

The findings of an i,iiernal auditor led to the recent finamial scandal at Wor$d(.nrn. The flrms new (E() asked aninternal auditor to spot-check various records related to capit4l expenditures. She subsequently discovered har thefirms chief financial officer was misapplving major expenses: Instead of treating then) as currrnt exiws. he wastreating them as capital expenditures. This treatment. in turn. iiade the firm look much more profitable than it reallwas. The CEO was fired, hut it will take Vorld( om a kng lime to sort nut the $3.8 billion It has 54) far found to havebeen handled iniproperly.4

Financial auditing is an accounting process used in business. It uses an independent body

to examine a business' financial transactions and statements. The ultimate purpose

of financial auditing is to present an accurate account of a company's financial business

transactions. The practice is used to make sure that the company is trading financially fairly,

and also that the accounts they are presenting to the public or shareholders are accurate

and justified.

The results of the financial auditing procedure can be presented to shareholders, banks and

anyone else with an interest in the company. One of the main reasons for a financialauditis

to ensure that the trading company is not practicing any deception. This is the reason that

the financial auditing body is an independent third party.
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