The Importance of Balance Sheets in Decision Making
Balance sheets are a core aspect of financial analysis with respect to the performance of a given company. According to Mintz and Morris (2010), a balance sheet is beneficial to a company in terms of the planning and evaluation required for growth. Depending on the contents of the document, a company is capable of making informed decisions that will steer it on the path to growth. A balance sheet is closely related to the resources of a firm. As such, it is essential for the effective management of a company’s finances.
The importance of this document can be seen in the substantiation of accounts. Zimmerman (2010) defines substantiation as regular accounting that ensures all records are properly reconciled. With the help of this development, a company can make proper decisions that will be presented using the data in the balance sheets. For instance, the company will be in a position to formulate strategies informing the management on the right moment to re-stock.
A balance sheet is also an avenue through which a company can make informed financial and operational forecasts. Zimmerman (2010) argues that the document helps a company identify the areas that can be exploited to increase profits. Consequently, decisions that tend to affect the future of the organization are informed by the data in a balance sheet. Other benefits of this document are seen in the decisions made by management with regards to the reduction of operating costs and financing options. As such, balance sheets are important in informing the strategies made by a company. They act as ‘outlooks’ of the organization’s particulars.
Types of Decisions Made using Data from Balance Sheets
Decisions Made
As already indicated, the data presented in this document affects the decisions made by the organization. Warren, Reeve, and Duchac (2013) suggest that balance sheets enable a company to come up with financial ratios. The ratios are used to determine the performance of the firm. Consequently, the management is in a position to make decisions needed to improve performance.
Balance sheets enable a company to make decisions that touch on its liquidity using the current ratio. Penman (2010) points out that a firm is considered to have sufficient liquidity when the current ratio is 2:1. When liquidity is insufficient, the management will decide on the best course of action to take to increase capital. In a similar fashion, the leadership can make decisions touching on the suitable strategy to increase profits. Gross and net profits, which are presented in a balance sheet, help in making the right decisions for the firm.
Decision Makers
The decisions illustrated above are made by the management of a company. However, Minnis (2011) argues that these decisions cannot be made unilaterally. For instance, when a balance sheet suggests low liquidity, the finance manager is required to come up with a solution to address the problem. However, given the gravity of the matter, the finance manager is expected to engage the board in identifying the appropriate course of action. Some situations call for the formulation of policies. In such cases, a consultative decision-making process is required.
It is important to appreciate that balance sheets will continue to inform decision-making in organizations. Logically, the management is expected to affect the decisions (Minnis 2011). However, the same should be carried out in a consultative manner, not unilaterally.
References
Minnis, M 2011, ‘The value of financial statement verification in debt financing: evidence from private U.S. firms’, Journal of Accounting Research, vol. 49 no. 2, pp. 457-506.
Mintz, S & Morris, R 2010, Ethical obligations and decision-making in accounting: text and cases, McGraw Hill, New York.
Penman, S 2010, Accounting for value, Columbia University Press, New York.
Warren, S, Reeve, M & Duchac, J 2013, Accounting, Cengage Learning: Michigan.
Zimmerman, J 2010, Accounting for decision making and control, McGraw-Hill, New York.