Business Management : The Financial Health Of The Company

When analysts question a firm’s earnings quality, it raises concerns regarding under or over aggressive accounting practices that may be allowing the firm to manipulate the earnings. Earnings quality is defined as the strength of the current earnings in being used to predict future earnings and cash flows. Since earning quality is indicative of future performance, analysts are more likely to address issues that have substantial impact on the earnings quality. An issue arises when the nature of the earnings is questioned. While permanent earnings are part of normal operations, any irregular, one time earnings can skew the earnings, making the firm look more profitable than it is. This is due to the inability to recreate similar one-time transactions that will give rise to such numbers. Investors prefer predictable

Understandably, there are a variety of ways in which a company can manage their earnings, and if accomplished successfully, the results can be highly profitable. Not all techniques are fraudulent, as effective earnings management is considered good for business and shareholders. Income smoothing is a specific example of permissible earnings management that involves controlling fluctuations in net income to make earnings less variable over a given period of time (Goel & Thakor, 2003). Smoothing is acceptable as long as it adheres to the restrictions of U.S. GAAP, which maintains that all revenues and expenses are accounted for in a defined fashion. There are a lot of incentives in figuring how to effectively smooth income, as substantial value can be created through the successful arrangement of financial transactions. Management is able to make more intelligent decisions with regards to the future of the firm if the earnings are able to match the forecasts. One instance this is seen is when management is faced with the decision to smooth total income or

Such an intense focus has been placed on quarterly earnings as an indication of a company’s success by everyone from analysts to executives that ethics have for the most part been thrown out the window, sacrificed to the all important number, i.e. earnings per share. This is the theory in Alex Berenson’s book “The Number: How the Drive for Quarterly Earnings Corrupted Wall Street and Corporate America.” This number has become part of a game to be played, a figure to be manipulated – beat the number and Wall Street all but throws a parade, miss it and a company’s stock may be abandoned. Take into account the incentives that executives have to beat the number and one can find plenty of reasons to manage earnings.

Several main reasons for the occurrence of earnings management include influencing the stock market, growing management compensation, decreasing the possibility of violating lending agreements, and averting government intervention. It is believed that managers might attempt to manage earnings because they believe reported earnings impact investor and creditor decisions. In most cases, earnings management techniques are designed to improve reported income effects and to lower the company’s capital cost. However, in order to increase future profits, management might take the chance to report more bad news in low performance

Companies practice earnings management to maximize/minimize earnings or to smooth out fluctuations in earnings (or more commonly known as income smoothing). The motivation can be derived from two sources: (i) contracting incentives, also known as Positive Accounting Theory (PAT), and (ii) capital market incentives, which is to meet earnings

The role of financial reporting is to portray the economic position of a firm in a timely and credible manner. These financial statements should serve as a useful information source for different stakeholders in making economic decisions. For information to be useful it should be relevant and reliable (accounting book). Because the reported earnings could affect the decision making of stakeholders or contractual outcomes which are related to remuneration of managers or debt covenants, managers have strong incentives to adjust earnings to a desired pre-determined level (Watts, 1990) . Although established accounting standards limit the use of opportunism, the determinant is that managers have flexibility in choosing the accounting method, and the existing information asymmetry between them and external stakeholders allows them to prepare the financial reports to their own advantage. Information asymmetry is the information advantage

Different companies or organizations in reference to any profit made by the company use the term earnings. As a result, earnings are very important to the company especially the listed companies as a means of investors for evaluating or analyzing in their determination of the attentiveness of any company or of a particular stock. In addition, earnings are very critical in the determination of the stock price of any company (Jim, 2012). Owing to this, any company with low earnings would typically have a lower share price compared to those with better prospects. Additionally, earnings represent the ability of the company to generate profit in the future thereby driving the stock price of the company.

An income statement is part of the three main financial statements (balance sheet and cash flow statement) companies are obliged to produce by law. It is dependent upon by stakeholder to show a true and fair view for decision making. For instance, a potential investor that is willing to invest in a particular company. But, the question arises as to whether an income statement reports the true profit of an entity, and to what extent it can be relied on by its users. On one side, accountants view that ‘profit is an increase in net wealth’ (Mac Neal, 1970). While, an economist might argues that profit should be seen as – ‘terse, obvious, and mathematically demonstrable’ (Mac Neal, 1970) in the accounts.

In Bradshaw and Sloan’s (2002) article, there are several evidences show that market participants like analysts, investors and managers are stressing on the Street earnings. Street earnings is favoured by the majority because it provides additional useful and relevant information and makes the firm look better since it generates higher value. GAAP (Generally Accepted Accounting Principles) earnings is the traditional measurement based on regulations and it is not relevant in predicting future cash flows. Examples of earnings in the wild market are Street earnings and non-GAAP earnings. Following the trends of using non-GAAP earnings, it is a good way to let the free market to create an efficient corporate financial reporting even there are

The most important item in the financial statements of a company is earnings. Earnings indicate the amount of value-added activities a company has engaged in over a period of time, as well as assist in the direction of resource allocation in capital markets. Just as the eyes are the window to the soul, earnings are the window to a company’s value. Increasing earnings represent an increasing company value, while the opposite can be said about decreasing earnings. Seeing how important earnings are to a company’s value, it comes to no surprise that management has a strong incentive to report earnings in their maximum

The financial health of a business greatly depends on its ability to maintain current commitments and obligations. Liquidity or the ability to generate cash from current assets to meet short-term obligations as well as unforeseen responsibility is important for the subsistence of a company. “A reasonable level of liquidity is essential to the survival of a company, as poor cash control is one of the main reasons for business failure. (Pyke, 2007) Through utilization of tools, such as liquidity ratios, or financial metrics, to evaluate the company’s ability to meet current business obligations, should the debt needs to be settled, we are able to assess its immediate financial strength. Liquidity ratios provide creditors as well as businesses a quick analysis tool, using data, which are readily available from annual financial statements, to complete these assessments. These ratios are critical to creditors and are “the most widely used ratios, perhaps next to profitability ratios.” (Joe Lan, 2002) Liquidity ratios include current ratio, quick ratio (also referred to as acid-test ratio), net working capital ratio, and cash ratio. Current ratio is the most basic or fundamental of the four and focuses mainly on current assets, while quick ratio is more stringent, eliminating inventory and prepaid expenses, as both are more difficult to liquidate (Morningstar, 2016). Cash ratio is the most “conservative”, as it mainly focuses on cash and investments

The concept of the earnings management is difficult to define and very subjective to decide. I believe that earnings management not only due to violation of GAAP but also aggressively choose GAAP method that are considered as earnings management. This broad definition may discourage earnings management and benefit

Design/methodology/approach: The study refers to a sample of Italian listed firms and the analysis covers three years, with a total of 591 firm-year observations. The modified Jones’ regression model has been used in estimating discretionary accruals, as a proxy of earnings management practices.

Evaluating earnings is very important as it gives an idea of the bank’s ability to maximize revenue and control expenses, and allows a bank to fund growth, cover losses, maintain adequate capital levels and pay dividends. It also represents the quality of a bank’s profitability and its competence to upkeep the quality of the banks and the quality and source of its earnings. The quality of earnings refers to if earnings can and will continue to support the needs of the banks and if they are coming from core earning sources or non-recurring events and are they sustainable. Earnings of JP Morgan Chase and Sagicor is done over a four year period, starting in 2011 and ending in 2014, as this is needed to understand the trend of changes amongst the two companies. Ratios used to analyse the two companies’ earnings are:

What is earnings management? According to the author it is the process by which companies artificially inflate or deflate their revenues or earnings per share. Schipper defines it as the management team deliberately intervene in the external financial reporting process with the purpose of securing some kind of private gain, which means their actions were not taken with the shareholders in mind, to whom they owe fiduciary duties towards. Instead they were for their own private gain. Healy and Wahlen’s definition constitutes the same principal of altering the financial statements but it also proposes the two main objectives of earnings management firstly, to mislead stakeholders about the economic performance of the company; secondly, to influence contractual outcomes which depends on the accounting figure.