Information Technology Reference
In-Depth Information
performance from different perspectives. Although some of these
measures can be calculated externally, being derived from annual
financial reports, and can be used to assess the same aspect of finan-
cial performance across different companies, care needs to be taken
to ensure that the same accounting principles have been used to pro-
duce the accounting numbers in each case. It is not uncommon for
creative accounting to occur so that acceptable results can be reported.
This draws attention especially to the interface between manage-
ment accounting (which is intended to be useful in internal deci-
sion making and control) and financial accounting (which is a major
mechanism by which external stakeholders, especially shareholders,
may hold managers accountable for their oversight).
Financial scandals, such as Enron and WorldCom have high-
lighted that a considerable amount of such manipulation is pos-
sible palpably within generally acceptable accounting principles
(GAAPs). There is clear evidence that financial numbers alone
are insufficient to reveal the overall financial condition of an enterprise.
Part of the cause has been the rules-based approach of US financial
reporting, in contrast to the principles-based approach adopted in United
Kingdom. One result of the reforms that have followed these scandals
has been a greater emphasis on operating information. In addition, leg-
islation such as the Sarbanes-Oxley Act (SOX) in the United States has
required a much greater disclosure of the potential risks surrounding
an enterprise, reflected internally by a much greater emphasis on risk
management and the maintenance of risk registers.
The finance function serves a boundary role; it is an intermediary between
the internal operations of an organization and the key external stakeholders
who provide the necessary financial resources to keep the organization via-
ble. Decision patterns like financial ratios allow internal financial managers
to keep track of a company's financial performance (perhaps in comparison
with that of its major competitors), and to adjust the activities of the com-
pany, both operating and financial, so as to stay within acceptable bounds.
A virtuous circle can be constructed whereby net cash inflows are suffi-
cient to pay adequate returns to financiers and also contribute towards new
investment; given sound profitability, the financiers will usually be will-
ing to make additional investment to finance growth and expansion beyond
that possible with purely internal finance. Conversely, a vicious cycle can
develop when inadequate cash flows preclude adequate new investment,
causing a decline in profitability, and so the company becomes unable to
sustain itself.
 
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