Financial Statements

Financial Statements Financial statements are a source of information for customers, creditors, managers, employees, regulators and other stakeholders of a firm to assess its past and future performance. The quantity of information available from the financial statements can be quite inundating. Financial statement users, therefore, adopt ratio analysis to counter this burden of information overload and get an accurate picture of the firm performance. Analysis of the financial statements of a company reveals important information to its stakeholders thereby leading them to make inferences about its financial condition and attractiveness as an investment. This paper will scrutinize the financial statements of Muslim Commercial Bank (MCB), Pakistans largest private bank by assets and market capitalization. MCB is the only financial institution from Pakistan that is listed on the London Stock Exchange. With its 60 year history, MCB has depicted a tremendous growth record and is listed on all stock exchanges in Pakistan with a significant market capitalization (Muslim Commercial Bank Annual Report, 2005). The financial information of MCB, as extracted from its 2005 annual report, provides an insight into the institution’s operations carried out in the year 2004-2005. To measure a company’s financial health, five categories of ratios1 are normally applied to the financial statements; liquidity, leverage, operating, solvency and profitability. Liquidity ratio measure whether a company has sufficient cash to meet its obligations as they fall due. Leverage ratio detects the impact of using creditor funds whereas operating ratio assesses whether the resources are effectively employed. Solvency attempts to detect financial tolerance of the company to ensure the company is not headed towards financial distress. Profitability ratio is a barometer of the company’s efficiency and success (Cinnamon and Helweg-Larsen 81). The results of the application of ratio analysis to MCB financial statements are shown in the appendix in table 1. The liquidity ratio of the company has improved as compared to the previous year, suring from 1.75 to 1.9. This is due to the improved cash flow generated in the year 2005. The other ratios also depict an uptrend signaling stability and consistency in growth. Profit after taxation for MCB for the financial year 2005 has increased more than 50% comforting all its stakeholders and eliminating any concerns about financial distress. Moreover, the company’s latest listing on the London Stock Exchange should further open the doors for capital injection and aid in the growth of the company. The information excerpted from the annual report is an evidence of the vital signs of the company to its stakeholders. The main stakeholders that closely monitor the business performance of an organization are the creditors, investors, and managers. This is due to the fact that their respective objectives are directly tied to the company’s performance. Creditors particularly pay close attention to the short-term liquidity and long-term solvency of the company (Emery 1998). An improving liquidity ratio for MCB should be very satisfying for its creditors. The magnitude of their conviction about the financial strength of the company is compounded by the fact that all the financial ratios of MCB for the year 2005 show a significant improvement. If the company has reserves to meet its obligations and enjoys a balanced debt-equity ratio, creditors are contented since there are no alarming signals pointing towards insolvency. Investors forecast risk and potential returns through the accounting information from financial statements. They closely watch a company’s earnings record to ascertain the probability of dividends and capital gains that can potentially flow from the company’s stock (Meigs et. al 438). Even though investors have an insatiable appetite for returns, the financial results of MCB for 2005 instill immense optimism in them especially taking into consideration the 20% dividend declared by the company. The consistent uptrend in the profits (refer to graph 1 in appendix) and the increasing earnings per share (EPS) ratio (refer to graph 2 in appendix) support the fact that business strategies are focused on maximizing shareholder value. The primary concern of the managers is to run the company as efficiently and effectively as possible to satisfy the creditors as well as investors in terms of meeting obligatory payments and maximizing shareholder value respectively. Should they fail to satisfy these stakeholders, the company can well be on its way to facing dire consequences, potentially even bankruptcy. Financial statements are a useful source of information for the managers, in that they see the result of their input throughout the year and learn to alter business strategies should the numbers warrant. The managers of MCB have shown a tremendous performance in generating healthy revenue for the business. A declining liquidity ratio should provide an incentive for an appropriate working capital management strategy for the following year. Annual report contains a great deal of information, which when correctly analyzed can provide signs on the direction of the company. For example, it is imperative to check if there is information on any missed payments, dividends in arrears or if the company has earmarked reserves for any significant commitments or loss contingencies. This information is vital for the investors and creditors as it can have a significant impact on the stock price and credit rating of the company. A thorough scrutiny of the annual report uncovers information on how the various risks (credit, interest rate, operational) are being managed and risk concentrations avoided. Financial statements of a company provide essential guidance to the investors and creditors leading them to make rational and informed decisions.