Links between financial statements and strategy
The prime link is that financial statements manifest the financial strategy. For example, the income statement is a record of how a sales maximization and cost minimization strategy has unfolded over past periods and the value-creative or value-destructive power of that strategy. The second vital link is that the balance sheet (the statement of financial position) is the end point of a past strategy and the starting point of a new or revised strategy. Without an appropriate balance sheet with regard to structure and amounts, certain financial strategies will be impossible to instigate or deliver.
Content, order and logic of this chapter
Within this chapter we will cover the following topics:
- The importance of cash records and reports
- Bedrock concepts
- Income statement - the P&L account
- Statement of financial position - the balance sheet
- their purpose
- what they can convey
Order and logic
Cash has to be monitored continually, because if we run out of cash the business will not function. Some form of cash report is a must, for monitoring and control purposes. For most entities, those that actively trade in goods, services or investments, cash or more likely bank transfers will be the initiator and result of the majority of statement figures. Indeed, the 'cash book' or bank statement is the prime source of record keeping for companies large and small. The chapter looks first at the need for cash records, the need for a cash book and daily reconciliation with bank statements, as cash recording and monitoring is an essential process when tracking a financial strategy. In the simplest of businesses, for example small charities, the financial statement is called a receipts and payments account. For larger entities there is a summarized statement of the cash flows into and out of the business, formally called Statements of Cash Flow and considered in Chapter 8.
There are two fundamental concepts which have to be understood, as they are literally bedrock to accounting and the financial statements we use every day. These are the going concern concept and the accruals or matching concept, which are introduced in this chapter and discussed further in Chapter 5.
The balance sheet shows both the amounts of, and the disposition of, net assets available to operate the business and how these net assets are funded, by borrowings or equity (shareholders' funds). It is essential to know the assets at your disposal and the liabilities that will have to be met when planning, delivering and monitoring operating strategy, particularly efficiency.
The P&L account/income statement tells you about revenues/sales costs and resultant profit or loss. Chasing sales, reducing costs and targeting a profit number can all be sub-strategies that lead to higher profits and thus returns. Understanding the income statement and the tactics to manage and improve profit is a must.
The P&L account, now formally called the Income Statement, is based on cash flows but with the addition of income and costs being accrued, that is, income earned or costs incurred but not settled in cash being included.