Essay Sample on Usefulness of Accounting Information to Investment Analysts

Introduction

Accounting information is an essential resource for groups of individuals having an interest in a given organisation. Like any other type of information, accounting information is vital in decision making regarding the operations of business organisations. Whether managerial or financial, accounting information helps various user groups to make decisions about the overall performance of a particular organisation. Amongst these groups, investment analysts stand out as some of the greatest beneficiaries of accounting information. Investment analysts play an intermediating role in sharing information between would-be investors and companies as well as other users (e.g., Regulatory authorities) who may have an interest in the activities of the firm and its overall performance in meeting expectations of society(Vergoossen, 1993). Investment analysts use accounting information to assess the riskiness of investments, forecast performance, estimate the impact of competition as well as evaluate the ability of firms to meet their debt obligations.

Is your time best spent reading someone else’s essay? Get a 100% original essay FROM A CERTIFIED WRITER!

Save 25%

Investment analysts use accounting information to assess the riskiness of portfolios or a combination of portfolios. The motivation for risk assessment is to offer advice to prospective investors. Investment analysts such as portfolio managers conduct, fundamental analysis, ratio analysis and beta analysis of income statement and balance sheet items to evaluate the riskiness of firm assets. Besides giving a picture of the potential performance of a firm's assets, assessment by investment analysts seeks to reveal the exposure of the particular firm to risks of debt repayment among other exposures (Vergoossen, 1993). Increased or decreased investment performance of securities in the stock market depends significantly on how positively or negatively users react to information revealed in the annual reports. Investors seeking to buy stocks in a given firm require information about its performance over a given period to make investment decisions. However, most of the investors may not have the skills and knowledge necessary to make sense of accounting information hence the need for people with the expertise to guide them accordingly (Ramnath, Rock, & Shane, 2008; Vergoossen, 1993). By examining the risks these portfolios, investment analysts assess the volatility of the returns of the individual stocks hence get the information required to provide appropriate advice to prospective investors on the expected returns of securities in the stock market at a given level of risk.

Closely related to the riskiness of portfolios is the riskiness of a firm is exposed as a result of its level of leverage. For analysts such as portfolio managers information about the indebtedness of a firm as shown in the annual reports is essential for them to make effectively play their role as intermediaries. For instance, the study of Day (1986) revealed that the balance sheet provides information for analysts to evaluate the riskiness of the firm as a result of its liabilities. Of great concern to many analysts in the study the off-balance sheet financing and liabilities of parent companies which have a significant effect on the organization in focus to owner its financial obligations. Another area of the annual reports that analysts spend much of their time is compliance with accounting principles. The study mentioned study also revealed annual reports enable analysts to assess and evaluate the level of compliance to the accounting principles and policies in the country/region in which they operate in reporting their financial situations. This information is useful for the analysts as it helps them to compare compliance in one sector with another hence determine the level of exposure to liabilities such as fines resulting from malpractices in their reporting. For investment analysts, information about activities that increase organizational liability is critical for them to offer advice to lenders about the ability of these organizations to make loan repayments. Thus, for investment analysts to get maximum gain from the role in advising clients about the riskiness of investing in a specified firm, they need annual reports to base their advice concerning viability.

The riskiness of a firm resulting from its exposure to debts is not the only factor that investment analysts use to evaluate the expected returns of securities. Investment analysts use accounting information to forecast the future performance of firms both regarding profitability and also in the stock market. The income statement provides a summary of the financial performance of an organisation over a fiscal year. The study of Vergoossen(1993) revealed that man investment analysts rank historical information lowly in using it to forecast the potential of an organization hence few consider it as an essential ingredient in their analysis. Therefore, the currency of the information is critical to the ability of the analysts to make better forecasts. Investment analysts use recent earnings of companies to attach intrinsic value to shares while considering factors such as bad news about the market as well as the overall performance of the industry. Although Arnold and Moizer (1984) found that forecast on what shares will be making over a given period in future purely depends on pure guesswork on the part of the analysts, forecasts help in assigning target prices for securities for firms. It should also be noted that even though the information obtained in the annual reports does not appear to the analysts as containing any sensitive information about prices of stocks (Ramnath et al., 2008; Day, 1986). Therefore, accounting information empowers analysts to become not only as active players in the stock market but also as the critical drivers of business in the market.

The setting of target prices is important in the sense that it helps analysts to make recommendations to potential investors on whether to buy stocks of certain companies. Analysts use annual reports of companies to estimate the possible price stocks for such companies would trade thereby setting the framework upon which the trading on the stock exchange is to take place. For instance, they gather, analyze and interpret numbers in annual reports to infer the prices of the shares of firms (Vergoossen, 1993). Good prices attract strong recommendations from the analysts and vice versa. However, the practice of assigning prices may be abused considering the nature of the business of analysts. For instance, Arnold and Moizer (1984) note that analysts who act as advisers may wish to persuade their clients to purchase certain securities based on the prices they have assigned. Such practice is motivated by the desire by the analysts to maximize on the commission they get from clients through sales and purchases of shares. Thus, many analysts make recommendations for buying to increase the purchase of stocks of selected firms which promote unfair trading.

Analysts also use the annual reports of companies to predict the overall direction of the industry in which businesses under focus operate. After analyzing and interpreting records from annual reports of companies, analysts use them to determine as to whether the industry in question has positive or negative growth prospects. They accomplish this by comparing not only annual reports of companies operating in the same industry but also different branches of a given industry to come up with the best estimate of the picture of the business in the sector of inquiry(Vergoossen, 1993; Day, 1986). The comprehensive income statement and the balance are the major statements used in this respect. Besides the information obtained from the analysis, investment analysts also rely on information from other analysts to make decisions. For instance, portfolio managers may use analysed information from investment analysts to come with conclusions about the overall performance of the industry (Vergoossen, 1993). The practice implies that drawing inferences about business trends is an important activity done by analysts to predict how a given industry and, indeed, the overall economy would perform over a specified period. Therefore, the annual reports act as a basis upon which analysts make policy recommendations to their clients as part of their intermediating job.

Conclusion

On the whole, accounting information appears to be a vital resource for investment analysts. For one, investment analysts use annual reports to assess the riskiness of portfolios offered to people who want to be investors in stocks and other securities. At the same time, accounting information helps analysts to evaluate the degree of leverage and its relationship with the ability of the firm to access credit facilities to finance its operations. Balance sheet items and compliance with accounting principles are areas that most analysts rely upon to evaluate the ability of business organisations to repay their debts. Moreover, the information is useful to analysts in forecasting the performance of the organisation as well as the industry in which such organisations operate. Some of these forecasting skills are used to assign prices to stocks and also estimate their potential returns in the stock exchange. Although analysts do not entirely on annual reports make their assessments about the value of a firm, they provide a solid basis upon which investment decisions are made.

References

Arnold, J., & Moizer, P. (1984). A survey of the methods used by UK investment analysts to appraise investments in ordinary shares. Accounting and Business Research, 14(55), 195-207. doi:10.1080/00014788.1984.9729209

Day, J. F. (1986). The use of annual reports by UK investment analysts. Accounting and Business Research, 16(64), 295-307. doi:10.1080/00014788.1986.9729330

Ramnath, S., Rock, S., & Shane, P. (2008). The financial analyst forecasting literature: A taxonomy with suggestions for further research. International Journal of Forecasting, 24(1), 34-75. doi:10.1016/j.ijforecast.2007.12.006

Vergoossen, R. G. (1993). The use and perceived importance of annual reports by investment analysts in the Netherlands. European Accounting Review, 2(2), 219-244. doi:10.1080/09638189300000020