Primary objective of financial reporting
Financial reporting is one of the key aspects that publicly traded companies should consider in their operations. The core purpose of financial reporting is to create awareness to various stakeholders such as employees, creditors, government, current and potential investors, and credit financiers regarding an entity’s financial position and performance. The financial reports are of great significance to external and internal users in their economic decision-making process (Peterson & Fabozzi, 2009).
Purpose and importance of financial analysis
In order to understand an entity’s financial performance, it is imperative for organizational managers and investors to undertake financial analysis, which involves examination of an organization’s historical financial data in order to understand the entity’s current and future financial health. Financial analysis aids in determining the stability of an organization by evaluating its financial solvency, liquidity, and profitability (Greuning, Scott & Terblanche, 2011). Subsequently, financial analysis assists investors and organizational managers in making critical decisions. Greuning, Scott, and Terblanche (2011) assert that business “goals and objectives are set in financial terms and their outcomes are measured in financial terms” (p.74). Therefore, financial analysis improves the use and significance of financial statements to internal and external stakeholders.
Financial performance; Exxon Mobil
Exxon Mobil has sustained a strong financial performance over the past years despite the prevailing global economic challenges (Exxon Mobil, 2013). Its financial performance can be illustrated by calculating a number of financial ratios such as the liquidity, profitability, return on capital, and return on investment.
Maintaining adequate liquidity is a fundamental aspect in an organization’s operations. Liquidity improves the efficiency with which an organization meets its short-term financial obligations (Fridson & Alvarez, 2011). Therefore, business organizations should maintain acceptable levels of liquidity. The liquidity of an organization can be determined by evaluating its current ratio, which assesses the degree to which an organization can meet the financial needs of short-term creditors. In a bid to meet such needs, organizations should maintain a current ratio of 1:1. Current ratio is calculated by dividing the total current assets with the total current liabilities. The table below shows that Exxon Mobil has sustained its current ratio within an acceptable level over the past two years; hence, the firm is liquid.
|Amount in Million dollars|
|Total current assets||59,308||64,460|
|Total current Liabilities||71,724||64,139|
|Current ratio||59308/71,724= 0.8:1||64,460/64,139 =1:1|
Return on Assets [ROA]
One of the ways through which organizational shareholders can assess whether organizational managers are effective in generating adequate profits using the company’s assets is by determining the return on assets. The return on assets is calculated by dividing the net income by the average total assets. The table below illustrates Exxon Mobil’s return on assets ratio.
|Amount in million dollars|
|Average total assets||173,404||166,898|
|Return on Assets||32,580/173,404X100%= 20%||44,880/166,898×100%=30%|
The table above shows that Exxon Mobil has sustained its return on asset at 20% and 30% during its 2012 and 2013 financial years. The rates of ROA show that Exxon Mobil was more effective in generating profit from its assets in 2012 as compared to 2013.
Organizations can adopt different avenues in their asset financing processes. Debt financing entails seeking credit finance from various financial institutions such as banks and the capital market. However, debt financing obligates a firm to pay back the principal amount advanced and the agreed interest within a specified period, which means that the financial risk involved is high. On the other hand, equity financing entails issuing shares to individual or institutional financiers, thus making them part owners of the organization. The financial risk involved in debt financing is minimal for the entity is not obligated to make any payments. However, the board of directors has the discretion on whether to pay dividends (Greuning, Scott & Terblanche, 2011).
Exxon Mobil finances its assets using both equity and debt sources of finance (Yahoo Finance, 2014). The extent to which the firm utilizes debt and equity sources of finance can be assessed by determining the debt-to-equity ratio, which is calculated by dividing total debts by total equity.
|Amount in million dollars|
|Debt to equity ratio||22,699/346,808 =0.06||7,928/333,795 =0.03|
The above table shows that Exxon Mobil has maintained its debt to equity ratio at a low level. Therefore, the firm is less leveraged, which means that it mainly depends on equity finance in financing its assets as opposed to debt financing.
Return on Capital Employed
Exxon Mobil’s management team is focused at ensuring that the capital provided by shareholders is utilized effectively in generating profitability in order to maximize the shareholders’ wealth. The firm invests the shareholders’ capital in diverse operational activities. However, the effectiveness with which the firm utilizes the capital provided can be assessed by calculating the rate of return on capital employed, which is involves dividing the total earnings before interest and tax by the total capital employed.
|Amount in million dollars|
|Earnings before interest & tax [EBIT]||57,711||78,726|
|Total capital employed||200,368||182,781|
|ROCE||57,711/200,368X100= 28%||78,726/182,781= 43%|
Table 4 above shows that Exxon Mobil has generated profitability from the capital provided by shareholders. However, the firm was more efficient in utilizing capital provided to generate profitability in 2012 as compared to 2013.
The effectiveness with which a firm creates shareholder value can be assessed by evaluating the shareholder return ratios such as the price earnings ratio, which examines an entity’s ability to pay shareholders for every dollar of profit made. The ratio is analyzed by dividing the market price per share by the earnings per share. Table 5 below shows that Exxon Mobil has improved its price-earnings ratio over the past two years, which illustrates its effectiveness in generating shareholder value.
|Market price per share||$99.65||$82.52|
|Earning price per share||$7.37||$9.70|
|Price earnings ratio||$99.65/$7.37 =14 times||$82.52/$9.70 =9 times|
Limitations of financial ratio analysis
First, the financial information used may be subject to some assumptions and estimations, which are permitted by the use of different accounting policies and standards. Consequently, the comparability of a firm’s financial performance across different years may be affected adversely. Additionally, comparing the financial performance of firms operating in different economic sectors using ratios is ineffective as their operations are subject to environmental conditions that are unique to their respective industries. Finally, ratio analysis is conducted based on historical information. On the other hand, the users of the financial reports may be concerned with the entity’s current situation. Subsequently, some of the target users may attach less value to financial statements.
Exxon Mobil: Financial statements and supplemental information. (2013). Web.
Fridson, M., & Alvarez, F. (2011). Financial statement analysis: a practitioner’s Guide. Hoboken, NJ: Wiley.
Greuning, H., Scott, D., & Terblanche, S. (2011). International financial reporting standards: a practical guide. Washington, DC: World Bank Publications.
Peterson, P., & Fabozzi, F. (2009). Analysis of financial statements. Hoboken, NJ: Wiley.
Yahoo Finance: Exxon Mobil; historical prices. (2014). Web.