To begin with, earnings figure is revenues minus cost of sales, operating expenses, and taxes, over a given period of time. Earnings are the reason corporations exist, and are often the single most important determinant of a stock's price. Earnings are important to investors because they give an indication of the company's past and expected future dividends and its potential for growth and capital appreciation. However, depending only on the earnings figure to estimate and predict the company's future is problematic. Because, it only shows the exact and real earnings figure in the past, but it is not a 100% accurate guarantee for well-being of the company in the future. There is no guarantee that if this year the company made 10 million profit, in the next year it will make the same or higher profit. Earnings per share and Price-Earnings ratio are two important types of earnings figure that investors will pay much attention when making the investment decision. Earnings per share (EPS) of a business is a portion its profit allocated to each outstanding share of common stock. It tells us the net profitability of a business, and shows the portion of a business's profit that is allocated to each share of the business. For instance, if you have 1000 shares, the EPS number can show you, what your amount of share of the profit from the business is. In calculating EPS we have to subtract any dividends paid to investors, because that amount of money is distributed among shareholders and investors. We use the formula below to calculate Earnings per Share. Earnings per Share (EPS) = Net Income ? Dividends on Preferred Shares Weighted Average Number of Common Shares Outstanding Next, Price-Earnings ratio (P/E) is the most popular method to measure of the cost of a stock and investors use this method widely. Basically, Price-Earnings of a stock shows us how much investors are ready to pay per dollar of earnings. In another words, a P/E ratio of 40 this means that investors in the stock are ready to pay $40 for each $1 of earning that the business generates. We use the formula bellow to calculate P/E ratio: C:UsersHoangAnhDesktopprice-to-earnings-formula.gif Source: http://www.theoptionsguide.com/price-to-earnings-ratio.aspx Generally, a low P/E is defined a sign that a stock may be undervalued or it is expected by investors to have a poor future earnings. On the contrary, a P/E with a high ratio indicates an over-valued stock, or investors expect a significant increase in earnings. The interest fact is that usually investors tend to buy a stock with a low P/E ratio rather buying the one with a high ration, because they will get more earning for their money. Earning only tells the story what the company did so far, but not what the company is going to do in the future. Definitely, the past earnings are important; however the potential future earnings figure is also important. This is important as if investors want to invest effectively and profitably, they would like to be sure that the company's earnings will increase in the future or at least won't drop. For example, we need to know if any new product is coming out or not. Like, Apple, it produces new iPhone every 6 months, so it can meet consumers' changing demands, therefore the earnings potential will be growing. Another example proving that earnings are the past information of the company and mostly helps to estimate only the company in the past - is Nokia Company. In 2009 they were the biggest phone company and had 49% of the market share which is huge; they almost dominated the market and had the huge earning statistics. Who could have thought that such a successful company with a gigantic earnings figure, in 2012 will have only 8% of market share and the earnings figure has dropped and keeps dropping significantly. This happened because they do not produce many new and innovative products. They kept and keep producing old-fashioned phones with old technologies and do not change the product line to meet the fast changing demand of consumers and trends of the market. Their past earnings figures are still high, however the present earnings figures are very low, and the future figures, apparently will be dropping. That is why the investors do not always estimate the company's future based only on earning figures; they take other factors into consideration. That is why the financial reporting is changing to meet the investors' requirements.
Changing Financial Reporting Firstly, financial reporting is written records of a business's financial situation. They include standard reports like the balance sheet, income or profit and loss statements, and cash flow statement. It is one of the most basic components of business information; it helps to communicate to external parties (such as investors, creditors, suppliers and etc.) about financial position of the company. In the past investors based only on financial ratios provided by the company to estimate the company's financial position and its potential growth. However, as mentioned before financial ratio talks only about the past figures, but this may not be repeated in the future. Nowadays, the market is very competitive, the world is a market, you may be in your country market, and companies from other country can come into your market. Hence, to be profitable and competitive you must know more information, besides the financial ratio. Before investing, investors will likely watch the financial ratio and also non-financial statement of the company. They might want to know about information on the state of the economy, industry and competitive considerations, market forces, technological change, and the quality of management and the workforce are not directly reflected in a company's financial statements. One of popular non-financial reporting is SWOT analysis. It examines the strength and weakness, opportunity and thread of the company. SWOT analysis shows to investors the objective of the company or project and identifies the internal and external factors that are favourable and unfavourable to achieve that objective. Strengths: characteristics of the company or team that give it an advantage over others in the industry Weakness: characteristics of the company that put it in disadvantage in comparison to others Opportunities: external chances that allow the company to increase sales or profit Threats: external factors that can cause trouble to the company C:UsersHoangAnhDesktopswot_img2.gif Source: http://zeldor.biz/2011/01/swot-analysis/ Investors will look if the company is using its strengths to take advantage of market opportunities, and if they can identify and work on weakness that might slow down their ability to take advantage of those opportunities. Another important factor that investors are keen to watch closely is how the company is aware of its threads, how they use their strength to eliminate the potential threads or at least manage to minimise them. Additionally, investors also care about if the company can work to define the weakness that may increase the criticality of threats. C:UsersHoangAnhDesktopSWOT-Analysis.jpg Source: http://www.easy-marketing-strategies.com/swot-analysis.html Here is an example of SWOT Analysis, in this case we analysise Apple Company. The smart and experienced investors are likely to analyse the financial statements and also will use other non-financial statements, such as this SWOT analysis into consideration before making a decision about whether they should invest in Apple company or not.
Conclusion In this assignment we have defined 3 parts of financial statements and its importance as a source of information for investors. Additionally, we have discussed two types of performance measures that investors pay much of attention to makes investment decisions: Traditional methods and Modern Approaches. In the last part we investigated why emphasizing only on earnings figures are problematic and discussed how financial reporting is changing to meet investors requirements, providing an example of non-financial reporting - SWOT Analysis.