10.4 Finance and Accounting Strategy

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Objective 1: The Use of Financial Statements in Developing Strategies

What Are Financial Statements?

Financial statements are official documents that show a business's financial performance and position. Think of them as a business's financial report card. There are three main ones you need to know:

• Income statement (also called the Profit and Loss Account) — shows how much revenue (money coming in from sales) the business earned, what its costs were, and whether it made a profit or a loss over a period of time (usually one year).
• Statement of financial position (also called the Balance Sheet) — shows what the business owns (assets) and what it owes (liabilities) on a specific date. It is a snapshot of the business's financial health at one point in time.
• Cash flow statement — shows how cash moved in and out of the business during the year. A business can make a profit on paper but still run out of cash, so this is very important.

How Do Businesses Use These Statements to Develop Strategy?

A strategy is a long-term plan for how a business will achieve its goals. Financial statements give managers the data they need to make smart strategic decisions. Here is how each statement helps:

Income Statement → Profit Strategy

• If the income statement shows that profits are falling, management might plan to cut costs (e.g. reduce staff or find cheaper suppliers) or increase revenue (e.g. launch new products or enter new markets).
• If gross profit margins are low, managers may decide to shift strategy towards higher-value products.

Statement of Financial Position → Investment and Financing Strategy

• If the balance sheet shows the business has a lot of debt (money owed to banks and creditors), managers might plan to reduce borrowing or raise new capital by selling shares.
• If the business has strong assets (things it owns, like property and equipment), it could use these as security to borrow more money for expansion.
• A healthy balance sheet with plenty of retained profit might encourage managers to invest in new equipment or acquire another company.

Cash Flow Statement → Liquidity Strategy

• If the cash flow statement shows that the business is regularly running low on cash (even if it is profitable), managers might decide to negotiate better payment terms with customers, or arrange an overdraft (a short-term borrowing facility from a bank).
• Persistent cash shortages might lead to a strategic decision to sell off assets or reduce stock levels.