By Enock Yeboah-Mensah
Understanding of financial statements is a core course that every business student is required to take in a business school irrespective of one’s major. In fact, it forms part of the first semester curricula in almost all MBA programs globally. In Ghana and in most parts of the world, publicly listed companies are required to publish their annual financial statements.
In the case of Banks and many other financial institutions, regulators require them to publish their unaudited financial statements quarterly and their audited financial statements annually. The Bank of Ghana also requires all banks to display their latest audited financial statements in banking halls.
Although financial statements are published in the dailies for the public, most do not really understand why companies make public their financial statements. This article is aimed at expounding the practice to the understanding of individuals without finance background.
Why Companies (Banks) Publish their Financial Statements.
Several financial theories highlight the practice of companies publishing their financial statements. Amongst these theories are the Efficient Market Hypothesis (EMH), Agency Theory, Stakeholder Theory, Capital Market Theory, Signalling Theory and Legal and Regulatory Requirements.
Capital Market Theory: One of the primary roles of capital markets (a place where people buy and sell parts of companies) is to facilitate the efficient allocation of capital (money to help companies grow). This theory suggests that when companies publish their financial statements it provides investors with the necessary information to assess investment opportunities and risks. Capital market theory stresses on the need for companies to provide accurate and timely financial statements in order to attract investment capital (how much money investors are willing to invest) as well as to reduce the cost of capital (how much companies pay investors for their investments).
A case in point is Access Bank (Ghana) Limited continuously reporting strong financial performance in their financial statements. As a result, investors are well informed about the opportunities associated with investing in Access Bank. So, when Access Bank goes to the Ghana Stock Exchange to raise capital to meet the increased minimum capital requirement for Banks, they are able to attract the needed investment capital.
Agency Theory: This theory tackles the principal-agent relationship between business owners(principal) and those who manage the business(es) on their behalf(agents). The business owners are the shareholders and those who manage the business(es) on their behalf are the management of the business. Shareholders entrust decision-making authority to management to operate the business with the objective of maximizing the shareholder wealth.
However, management may pursue their own interest rather than maximising shareholder wealth. Publishing financial statements bridges the information gab between shareholders and management to ensure that both groups have access to the same information and share common objectives. It allows shareholders to monitor the performance of management and hold them accountable for their actions.
A practical example is Standard Chartered Bank (Ghana) Ltd consistently reporting strong financial performance and transparently communicating its growth strategies to shareholders. By so doing, investors are confident that management decisions are aimed at maximising shareholders wealth and the latter remain invested in the Bank for a long time.
Efficient Market Hypothesis (EMH): This theory suggests that financial markets are efficient and thus incorporate all available information into stock(share) prices. This means companies need money from people (investors) to undertake activities (provide a service or produce a product) that generate profit. The companies raise the money they need to undertake the activities by issuing shares to investors (who becomes shareholders after buying the stocks).
The value of the investors’ money now depends on how much other people are willing and able to pay for the shares the investors hold. According to the EMH, by publishing financial statements, companies provide information to investors holding its stock on whether to sell and how much to sell them for.
It also provides prospective investors information on whether to buy its stocks and how much to pay for them. Thus, the EMH posits that timely disclosure of financial information ensures that the stock prices of companies reflect their true value to investors to inform investment decisions.
An example is MTN Ghana Ltd reporting higher than expected profit in its financial statements for the year 2023. Investors who see the positive news rush to buy shares of MTN Ghana Ltd with the anticipation of its value increasing. As a result, the demand for MTN Ghana Ltd shares rises leading to an increase in its share price. This shows how share prices adjust rapidly to reflect the new information presented in the financial statement.
Stakeholder Theory: This theory supports the argument that companies have responsibilities not only to shareholders but also to other stakeholders such as employees, customers, suppliers, and the general public. Publishing financial statements promotes transparency and accountability to stakeholders by providing insight into companies’ financial health, operational performance and decision-making processes that affect stakeholders.
An empirical example is ABSA Ghana Ltd presenting the implementation of sustainable business practices, environment prioritization initiatives and social responsibility undertaken in their financial statements. As a result, it attracts environmentally conscious consumers, strengthens relationships with international partners, motivates employees, and enhances its reputation in the country. Although it may seem expensive in the short-term, it will contribute significantly to long-term performance and stakeholder value.
Signalling Theory: Financial statements of companies communicate information about their financial performance, operational performance and prospects that is vital to investors and other stakeholders in decision making. This theory suggests that, by publishing financial statements, companies signal investors and other stakeholders that they are confident in their business operations, management’s competence and commitment to transparency and accountability.
Suppose the financial statements published by Fan milk Ghana Ltd show that it meets and exceeds its earnings forecasts and dividends. Investors interpret this as a positive signal of the company’s financial health and management competence. As a result, the company’s share price increases, reflecting investor confidence, and attracting additional investment.
Legal and Regulatory Requirements: In many countries, companies are legally required to publish their financial statements to comply with accounting and legal regulations. These regulations aim to protect investors, ensure market integrity, and promote transparency and disclosure in financial reporting.
An empirical case is GCB bank (Ghana) Plc diligently complying with financial reporting standards and disclosure requirements mandated by the Bank of Ghana in their published financial statements. This leads investors to have confidence in the accuracy and reliability of the Bank’s financial information, reducing uncertainty and enhancing market transparency.
In conclusion, the publication of financial statements serves several purposes, including facilitating capital allocation, mitigating agency conflicts, enhancing market efficiency, fulfilling stakeholder expectations, signalling company performance, and meeting legal and regulatory requirements. These purposes can only be achieved when the users of the information contained in the financial statements understand it. Unfortunately, many people who fall in the category of stakeholders of companies do not really understand financial statements published by companies. It is for this reason that the next article in the series “Understanding Financial Statements” will focus on “how to interpret financial statements’.
The author is an Mphil Finance graduate of the University of Ghana Business School and a member of the Institute of Chartered Accountants Ghana.
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