financial representations definition

The Key to Trust in Financial Reporting: Faithful Representation

Explore the essence of reliable financial reporting through the lens of faithful representation and its role in fostering trust and transparency.

Trust in financial reporting is not just a regulatory requirement; it’s the bedrock of investor confidence and market stability. The concept of faithful representation plays a pivotal role in ensuring that financial statements accurately reflect a company’s performance and position.

Why does this matter? Financial reports are more than mere numbers on paper; they inform critical decisions—from individual investments to corporate strategies and policy making. Without trust in these documents, the entire economic ecosystem could face uncertainty and risk.

Faithful representation acts as a compass for reliability in financial information, guiding both preparers and users towards transparency and accountability. It is essential for maintaining the integrity of financial markets and fostering an environment where stakeholders can make informed decisions based on credible data.

Faithful Representation in Financial Reporting

Faithful representation in financial reporting is a fundamental principle that ensures financial statements are a true mirror of an entity’s economic activities. It requires that the information presented is complete, neutral, and free from material error, allowing stakeholders to see a financial panorama that is not distorted by inaccuracies or bias. This principle is enshrined in accounting standards and is a benchmark for the quality of financial information.

The importance of faithful representation is underscored by its role in the decision-making process. Investors, creditors, and other users of financial statements rely on the veracity of the information to allocate resources efficiently. If the financial reports were to be misleading, it could lead to suboptimal investment decisions and misallocation of capital, which in turn could have far-reaching consequences for the economy.

Transparency is a byproduct of faithful representation. When financial statements are prepared with this principle in mind, they provide a window into the company’s operations and financial health that is clear and unobstructed. This transparency is not just about disclosing figures but also about providing context and explanations that help users understand the numbers. It is about painting a picture that is as close to reality as possible, without embellishment or omission.

Attributes of Faithful Representation

The attributes of faithful representation are critical components that ensure financial information is depicted accurately. These attributes serve as the pillars that uphold the integrity of financial reporting, and they are essential for users who depend on these reports for making economic decisions. Let’s delve into each attribute to understand their significance and impact on the trustworthiness of financial statements.

Completeness

Completeness in financial reporting is about ensuring that all necessary information is included in financial statements. This means that all transactions and events that should be recorded are indeed captured and that relevant disclosures are made. For instance, the International Accounting Standards Board (IASB) in its Conceptual Framework for Financial Reporting, outlines that an omission can cause information to be false or misleading and thus not be helpful to the users of financial reports. Completeness also extends to the process of including all the necessary explanations and supporting details that give a full picture of the company’s financial performance and position. This comprehensive approach helps users to understand the scope, nature, and implications of the data presented, enabling them to make more informed judgments about the entity.

Neutrality is the absence of bias in financial reporting. It means that the preparation and presentation of financial statements are not influenced by any particular interests or agendas. The goal is to provide information that is impartial, objective, and fair. According to the Financial Accounting Standards Board (FASB), which issues the Generally Accepted Accounting Principles (GAAP) in the United States, neutrality means that “information cannot be selected to favor one set of interested parties over another.” An unbiased approach ensures that all stakeholders can rely on the financial statements without concern that the information has been manipulated to achieve a certain outcome or to hide unfavorable aspects of the company’s financial health.

Free from Error

While absolute accuracy in financial reporting is an unattainable ideal due to the inherent uncertainties in business, the attribute of being free from error means that there are no mistakes or omissions in the data that would materially mislead users. The information should be as accurate as possible, and any estimates or judgments made in the preparation of financial statements should be based on sound evidence and assumptions. The FASB’s Conceptual Framework states that “free from error” does not imply perfectly accurate in all respects, but rather that the information is free from errors and omissions to the extent that it would be misleading. This attribute enhances the reliability of financial statements and contributes to the overall trust that users place in the reported financial position and performance of an entity.

Building Trust with Faithful Representation

The trust engendered by faithful representation in financial reporting is not merely a byproduct but a deliberate outcome of meticulous and transparent accounting practices. When financial statements are prepared with a commitment to reflect the true financial state of an entity, they become a reliable foundation upon which investors and other stakeholders can build their economic decisions. This trust is not static; it is continuously reinforced each time a company’s financial information withstands the scrutiny of audits, market analysis, and regulatory review.

The process of building trust through faithful representation involves a dynamic interaction between the preparers of financial statements and their audience. Preparers must engage in rigorous accounting practices, ensuring that every figure reported is backed by verifiable data and that all relevant information is disclosed in an understandable manner. On the other side, users must be able to engage with the financial statements, interpreting the data within the context of the entity’s operations and the wider economic environment. This two-way street of communication and understanding fosters a relationship of trust that is essential for the smooth functioning of financial markets.

Moreover, the role of external auditors and regulatory bodies in this trust-building process cannot be understated. By providing independent verification of financial statements, auditors play a significant role in affirming that the information presented is a faithful representation of the company’s financial reality. Regulatory bodies, through the enforcement of accounting standards and oversight, ensure that there is a consistent framework within which financial information is reported and assessed. This external validation serves as a reassurance to stakeholders that the financial information they are receiving is not only prepared with integrity but also meets the high standards set by the accounting profession and regulatory authorities.

Ensuring Faithful Representation in Statements

Ensuring that financial statements faithfully represent a company’s financial position requires a proactive and disciplined approach. It begins with the adoption of robust accounting policies that are in line with established standards and frameworks. These policies must be consistently applied and regularly reviewed to adapt to new transactions, evolving standards, and changes in the business environment. The use of advanced accounting software can aid in this process, providing tools for accurate record-keeping, data analysis, and reporting. For example, software like SAP ERP Financials and Oracle NetSuite can help manage complex financial data and ensure compliance with reporting standards.

The governance of financial reporting is also instrumental in ensuring faithful representation. This involves oversight by boards of directors and audit committees, who must have a clear understanding of the financial reporting process and the company’s internal control systems. Their role is to provide oversight and challenge to the financial reporting process, ensuring that the information presented is reliable and that the company’s financial reporting function is adequately resourced and staffed by individuals with the appropriate expertise.

Training and development of accounting personnel play a crucial role in maintaining the quality of financial reporting. Continuous professional education ensures that those responsible for preparing financial statements are up-to-date with the latest accounting standards, regulatory requirements, and best practices. This education empowers them to identify and address potential issues that could compromise the integrity of financial reports.

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Vouching in audits for robust financial integrity, you may also be interested in..., modern trends and techniques in financial auditing, inside directors: roles, responsibilities, and impact on corporate boards, external auditors: their role and impact on corporate governance, forensic accounting: principles, techniques, and career paths.

• Accounting Principles
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• Monetary Unit Assumption
• Fraudulent Financial Reporting
• Time Period Principle
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• Relevance and Faithful Representation
• Materiality Concept
• Substance Over Form
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Relevance and faithful representation are the two fundamental qualitative characteristics of useful financial information. Relevance refers to the property of information being capable of making a difference in decisions made by users of that information. Faithful representation refers to an information’s ability to represent underlying economic phenomena faithfully.

Information is relevant if either it can be used as input in processes used to identify future outcomes (i.e. it has predictive value) or it can confirm past evaluations about economic phenomenon (i.e. it has confirmatory value) or both. For example, disclosure about current year revenue is useful in making predictions about revenue next year but it also helps in confirming whether last year prediction was correct. Similarly, impairment charge revises a user’s valuation of an entity’s net assets, and so on.

Faithful representation

Faithful representation is achieved when the financial information represents not just the legal form but the underlying economic substance of transactions. This is achieved when the information is complete, neutral and free from error.

Completeness means disclosure of all information necessary for proper understanding of the underlying phenomena.

Neutrality requires an unbiased depiction of economics and involves exercise of prudence such that neither current period earnings are overstated or understated nor those of future periods.

Free from error means that the underlying process used to prepare the financial information being presented. It does not mean 100% accuracy because the cost of achieving it might be too high.

Trade-off between relevance and faithful representation

In many cases, it is easy to present information which is both relevant and which presents the transactions faithfully but in some instances, we might need to strike a balance between both requirements. Relevance and faithful representation are both critical for the quality of the financial information, but both are related such that an emphasis on one will hurt the other and vice versa. Hence, we have to trade-off between them. Accounting information is relevant when it is provided in time, but at early stages information is uncertain and hence less reliable. But if we wait to gain while the information gains reliability, its relevance is lost.

• After the balance sheet date but before the date of issuance of financial statements, a company wants to dispose of one of its subsidiaries and is in final stages of reaching a deal but the outcome is still uncertain. If the company waits, the uncertainty would resolve and it can disclose more certain information which would represent the underlying phenomena more truthfully. But this would be at the cost of reduction in relevance. The information would be outdated and no longer very relevant.
• The uncertainty surrounding a company’s potential liability in a legal claim might be too high thereby making the estimate not very accurate. However, the company might still present an estimate, even if not fully true and fair, and explain the sources of uncertainty for the sake of relevance.

by Obaidullah Jan, ACA, CFA and last modified on Oct 24, 2020

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Faithful Representation

How much do you know about faithful representation, share this post, related posts, substance over legal form, materiality concept, reliability concept, accounting concept and principles.

What is Faithful Representation in Accounting? Definition, Concept and Examples

Faithful representation definition.

Faithful representation in accounting means that the financial information shared, accurately reflects the real financial picture of the business.

In other words, faithful representation should give users of the financial statements confidence that what they are reading is honest and truthful.

For example, if a business reports that they generated £3m of annual revenue on their income statement, then that total should be able to be verified.

Faithful representation covers all of the financial statements – income statement, balance sheet and cash flow statement.

What are the Three Elements of Faithful Representation?

For financial statements to be a faithful representation of a business, they would have the following three elements:

• Free from error

Let’s look at each one of these elements in more detail:

Faithful representation requires that financial information is complete, and therefore provides a full picture of the economic events and transactions of the business.

Exclusions can distort the true financial position of a business.

For example, when preparing financial statements, it is crucial for faithful representation that all relevant transactions should be included, even ones that might seem insignificant.

Neutrality highlights the importance of presenting financial information without bias.

Information should not be manipulated to favour certain stakeholders or to achieve specific financial outcomes.

For example, when a business is determining the fair valuation of assets and liabilities, unbiased estimates are crucial for faithful representation.

Free from Error

Accuracy is another extremely important concept in faithful representation. Financial information must be free from material errors to ensure that stakeholder can rely on it for any decisions that need to be made.

This is generally achieved through internal and external audits, plus stringent internal controls within a business.

Examples of Faithful Representation in Accounting

To further help understand faithful representation, let’s look at some real-world example scenarios:

Impairment of Assets

Imagine a business that acquired another business and recorded goodwill on their balance sheet.

Over time, the performance of the acquired entity may indicate a potential impairment of goodwill.

Faithful representation requires the business to assess the value of goodwill regularly and impair it if necessary, providing a more accurate reflection of the company’s actual financial position.

Bad Debt Provisions

For businesses that sell goods or services on credit, they must create provisions for potential bad debts to faithfully represent the value of the debtor book.

If the business fails to do so, they may overstate their assets and income, giving a false impression of their financial position.

By creating sensible provisions based on historical data and current economic conditions, the financial statements can faithfully represent the true value of accounts receivable.

Contingent Liabilities

Imagine a business that is involved in a legal dispute where the outcome is uncertain.

To provide a faithful representation, they should disclose the details of a contingent liability in their financial statements.

If the business understates the potential liability, it could mislead stakeholders about the risks it faces.

In this instance, faithful representation would involves disclosing the details of the contingency, including the possible range of outcomes and the likelihood of occurrence.

Revenue Recognition

Imagine a software company that provides a subscription based service.

To faithfully represent the revenue received, the business should recognise subscription fees over the period during which the service is provided.

If the company recognises all subscription fees upfront, it might distort the financial picture, as the revenue hasn’t actually been earned yet.

By recognising revenue evenly over the subscription period, the financial statements faithfully represent the businesses performance.

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• Saturday, September 14, 2024
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• June 5, 2022

Difference Between Fair Presentation and Faithful Representation

Fair presentation is an accounting standards’ requirement that an entity’s financial statements should be presented in a fair way to all relevant users of these statements. In other words, it is premised on the requirement that these statements should not be misleading. Under the principle of fair presentation, financial statements must fairly present the financial position, financial performance and cash flows of the entity. Fair presentation requires the faithful (unbiased) representation of the monetary effects of transactions, other events and circumstances in accordance with the applicable concepts and recognition criteria for assets , liabilities , income and expenses .

On the other hand, faithful representation is an accounting concept (or principle) that entails that an entity’s financial statements shall be prepared and produced in a manner that accurately reflects the real state of affairs of that entity and the conditions under which it operates. In other words, faithful representation implies that the information presented in the financial statements should reflect the transactions and events that occur during a period in a manner that represents their true economic substance rather than merely their legal form.

Fair presentation is an expected outcome of maintaining qualitative characteristics (particularly, reliability ) of financial reporting and the application of accounting standards. Financial statements are meant to fairly present an entity’s financial position, financial performance and cash flows. A major requirement for fair presentation is the faithful representation of the monetary effects of transactions, other events and conditions in line with the applicable concepts and recognition criteria for assets, liabilities, income and expenses.

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Faithful Representation

Published on :

21 Aug, 2024

Blog Author :

Edited by :

Shreya Bansal

Reviewed by :

Dheeraj Vaidya

What Is Faithful Representation?

Faithful Representation refers to an accounting concept that emphasizes accurate reporting of a company's actual financial position in compliance with the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB). Thus, the firm's financial statements and reports should be unbiased, complete, and independent from material errors.

It is a critical qualitative characteristic that makes the business's financial information valuable for the company's investors, creditors , shareholders , regulators, and other parties for critical decision-making. This is because it brings out an accurate picture of the firm's financial performance and condition. Moreover, it applies to all financial statements , including balance sheets and cash flow statements . 

Table of Contents

Faithful representation explained, characteristics.

• Faithful Representation Vs. Relevance

Frequently Asked Questions (FAQs)

Recommended articles.

• Faithful representation emphasizes reporting the true and accurate financial information of a company.
• The three elementary components of this accounting concept are complete, neutral, and error-free financial reporting.
• Such attributes are essential to make the company's financial insights reliable and valuable for its stakeholders, investors, managers, creditors, and other parties.
• The reliability of the firm's financial statements is enhanced through factors like verifiability, understanding, comparability, and timeliness.

Faithful representation is a critical aspect in ensuring that the firm's financial reporting is trustworthy and includes all the facts related to a company's performance and condition. It serves as a basis for making informed investing, lending, and strategic decisions for the business. Moreover, the financial insights should be verifiable, comparable, and understandable at the same time. It even helps the firm comply with tax laws and reporting regulations while improving its reputation due to its financial transparency to various stakeholders .

Although faithful representation in accounting is crucial for businesses, the accounting team faces immense challenges in ensuring the trustworthiness of the enterprise's financial statements. The foremost difficulty arises in the selection of suitable accounting policies that align with the substance over form objective of the company. Moreover, some events or transactions are intricate and complex to report in the books. Indeed, it is again challenging to maintain comprehensive and real-time information in businesses where a lot of small transactions take place daily. To deal with such issues, the accounting team should strictly adhere to the principles and guidelines of the company.

The faithful representation in accounting can be achieved when the company's financial information demonstrates the following attributes:

• Completeness : The financial statements are supported by disclosures, and the transactions, conditions, and events cover all the related facts that reflect the firm's financial performance and position.
• Neutrality : It is equally necessary to maintain the objectivity of the financial reports by ensuring that these are unbiased and not influenced by any person or group for deriving personal benefits.
• Free From Errors : Simultaneously, the books of accounts should be accurate and should not have any material errors or misstatements that would otherwise impact the viability of such information.

The reliability of a company's financial information can be better understood with the help of the following real-world examples:

Suppose XYZ Ltd. reported its financial information for the accounting period ending on December 31, 2023. However, the following faithful representation issues were found during the audit:

• Completeness: The transactions worth $1,500 for goods sold in cash (as per the cash receipts) should have been accounted for in the income statement .
• Neutrality: A sleeping partner in the business, John, has drawn a $6,000 salary for the company's active management .
• Free From Errors: The electricity charges for October 2023 were recorded twice in the books, elevating the expenses by $2,700.

The WorldCom scandal involving $3.85 billion in accounting irregularities shook investors and the public, leading to CFO Scott Sullivan's dismissal and SEC fraud charges. The company wrongly booked line costs as capital expenditures , artificially inflating profits. However, some of the red flags, like consistent, smooth earnings growth, should prompt investor skepticism. 

While some call for changes to Generally Accepted Accounting Principles (GAAP), experts emphasize the need for more vigorous enforcement and governance to prevent future scandals. CEO certification of financial statements is suggested but faces feasibility challenges. Auditing reforms are crucial, as auditors missed systematic misclassifications at WorldCom. Overall, the scandal emphasizes the importance of faithful representation, transparency, accountability, and rigorous oversight in corporate governance and financial reporting.

Faithful representation in accounting serves as a critical requirement when it comes to financial reporting and taxation. Let us discuss the various reasons for its significance:

• Reflects True Financial Position : The faithful representation of the company's finances facilitates the business to represent its fair financial condition and performance to the stockholders , investors, creditors, regulators, and other associates.
• Fosters Transparency : The reliable reporting of a business's financial information can enhance the transparent communication and accountability among the various stakeholders of the company.
• Ensures C ompliance with Accounting Standards : The companies that maintain accuracy and reliability in their financial reporting are more compliant with the accounting standards of IASB and FASB.
• Supports Financial Analysis : A faithfully represented accounting statement can help stakeholders perform various financial analyses , including ratio analysis , trend analysis , and other performance analyses.
• Empowers Decision-Making : The financial reports of a company should be reliable as they are crucial for decision-making by internal and external parties such as managers, directors, investors, lenders, regulators, and shareholders.
• Enables Comparability : When the company follows a consistent practice of fairly representing its financial information, it aids in the comparison of business performance across different accounting periods and with the financial position of its competitors.
• Ensures Verifiability and Auditing : The regulatory bodies and tax authorities can cross-verify a firm's financial transactions and events with supporting documents.
• Builds Stakeholders' Trust : As the business accurately reports its financial insights to its stakeholders, they develop confidence and trust in the company and its management.

Faithful Representation vs Relevance

Relevance and faithful representation are two inevitable qualitative attributes of financial reporting of companies. However, given below are some of the primary differences between these two accounting concepts :

A company can check the reliability of its financial statements by ensuring that it accounts for all the transactions without any bias, material errors, or misstatements. Moreover, the transactions must have relevant supporting documents and disclosures for factual evidence.

As per the International Accounting Standards Board (IASB), four factors facilitate the faithful representation of financial reports: verifiability, comparability, understandability, and timeliness.

Reliability in accounting refers to the accuracy and dependability of financial information, ensuring that it is free from material errors and bias. On the other hand, faithful representation is a broader concept encompassing completeness, neutrality, and freedom from errors, emphasizing the true reflection of a company's financial position and performance. While reliability focuses on the accuracy of data, faithful representation extends to the overall integrity and transparency of financial reporting.

This article has been a guide to what is Faithful Representation. We explain its examples, characteristics, comparison with relevance, and importance. You may also find some useful articles here -

• Matching Principle of Accounting
• Conservatism Principle of Accounting
• Accounting Principles

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• Qualitative accounting characteristics
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This article relates to learning outcome A1 of the FA2 syllabus ‘The key principles, concepts and characteristics of accounting’.

The focus for this article is on the qualitative characteristics of useful financial information and has been written to complement the FA2 article titled ‘Principles and concepts of accounting’ (see 'Related links').

What are the qualitative characteristics?

Learning outcome A1(b) requires candidates to ‘Explain the qualitative characteristics of useful financial information. The Conceptual Framework for Financial Reporting (the Conceptual Framework) identifies two  fundamental  qualitative characteristics and four  enhancing  qualitative characteristics relating to useful financial information:

Fundamental qualitative characteristics

• Faithful representation

Enhancing qualitative characteristics

• Comparability
• Verifiability
• Understandability

Financial reports include financial information and, when preparing these reports, consideration should be given to the type of information that is likely to be most useful to existing and potential investors, lenders, and other creditors for making decisions about the reporting entity.

If financial information is to be useful then it must be relevant and must also faithfully represent what is being reported. The usefulness of this information is enhanced if it is comparable, verifiable, timely and understandable.

Each of these qualitative characteristics will be considered below.

Relevance Financial information is relevant if it is capable of making a difference in the decisions made by users of that information. Such information can make a difference if it has:

• predictive value
• confirmatory value, or

Predictive value means that the information can be used to predict future outcomes. The financial information itself does not need to be a prediction or a forecast but can be interpreted by users to allow them to make their own predictions. For example, current year revenue information could be used as the basis to predict revenue in future years.

Confirmatory value means that the information provides feedback on previous evaluations (ie it allows users to confirm or change their opinion on such evaluations). For example, the same current year revenue information indicated above could be compared with revenue predictions which had been made in prior years to correct or improve processes that were used to make those previous predictions.

As you can see, the predictive value and confirmatory value of financial information are interrelated.

Determining whether financial information is relevant involves considering materiality. More information on materiality can be found in the article ‘Principles and concepts of accounting’.

Faithful representation The Conceptual Framework uses the term ‘economic phenomena’ to refer to information about an entity’s economic resources, claims against the entity and the effects of transactions and other events and conditions that change those resources and claims.

An entity’s financial report represents such economic phenomena in words and numbers. As well as being relevant, the substance of these phenomena must be faithfully represented.

The Conceptual Framework identifies that to be a perfectly faithful representation, a depiction of any economic phenomena would need to be:

• neutral, and
• free from error.

Although such perfection is rarely (if ever) achievable, faithful representation requires that the above qualities should be maximised to the extent possible.

For information to be complete it must include all information necessary for a user to understand it.

Neutrality means that there is no bias in the selection or presentation of financial information.

Being ‘free from error’ does not mean that the information needs to be perfectly accurate. Rather, that there are no errors or omissions in the depiction of any phenomena and that the processes used to produce the reported information have been selected and applied with no errors in the process. For example, in some circumstances an estimate could be used in determining financial information. Although it may not be 100% accurate, such an estimate might still be faithfully represented as long as the amount is described clearly and accurately as being an estimate, the limitations of the estimating process are explained, and no errors were made in selecting and applying an appropriate process used for developing the estimate.

Comparability Users of financial information make decisions between alternative courses of action. For example, whether to sell or hold an investment in the shares of a company. Therefore, financial information is more useful if it can be compared with similar information about other entities and with similar information about the same entity for another period or date.

Verifiability When information can be verified, it gives assurance that the information faithfully represents the economic phenomena being represented. For information to be verifiable, it means that different knowledgeable and independent parties could reach consensus (although not necessarily complete agreement) that a particular depiction is a faithful representation.

Timeliness In general, the sooner information is available, the more useful it is. Although some information may continue to be timely for a long time (for example, information used to identify and assess trends), newer information is usually more useful than older information.

Understandability Classifying, characterising, and presenting information clearly and concisely makes it understandable. Some information required for financial reports is inherently complex and, although leaving such information out may make financial reports seem easier to understand, it would also make them incomplete. This ultimately does not aid understandability. Financial reports are intended for use by users with a reasonable knowledge and the Conceptual Framework accepts that even knowledgeable users may need to seek advice to aid their understanding of more complex issues.

Candidates must have knowledge of the fundamental and enhancing qualitative characteristics. Further, by ensuring that the key points of each of these qualitative characteristics are understood, candidates should be better prepared to answer questions that might arise in the exam

Written by a member of the FA2 examining team

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What's Market: Financial Statement Reps

Goulston & Storrs M&A attorney Dan Avery is a nationally recognized expert on M&A deal point trends. In partnership with Bloomberg Law, Dan has developed a series of 25 articles looking at these trends, on a topic-by-topic basis, providing practical insight into where these trends are heading, and the relevant implications for M&A deal professionals.

Market Trends: What You Need to Know

According to the American Bar Association's Private Target Mergers and Acquisitions Deal Points Studies, financial statement representations are universally required from sellers in private company M&A deals, included in almost every transaction—99% covered by the most recent study in 2021. Prior ABA studies showed these representations included within comparable levels of reported transactions.

At the same time, these financial statement representations are usually not GAAP-qualified, even if they include, as is common, a separate GAAP-specific representation. In the 2021 study, only 17% of the financial statement representations were GAAP-qualified. Over the 15+ years covered by the ABA's studies, this percentage has ranged from 14% to a high of 24%.

Sellers and buyers also continue to negotiate the precise language of financial statement representations, and whether separate “component” seller representations—i.e., representations covering “components” of or topics directly related to, financial statements, such as inventory, accounts receivable, and books and records—should also be included in their transaction documents.

Introduction

U.S.-based M&A agreements, whether asset purchase agreement, stock purchase agreement, or merger agreement, typically contain a seller representation relating to the target company's financial statements. This article examines trends in financial statement representations in private company M&A transactions, including trends as reflected in the ABA studies.

Scope & Prevalence of Financial Statement Representations  A typical financial statement representation may read:

Attached hereto as Schedule X are the following financial statements: (i) the audited balance sheets of the Company as of December 31, 2021, December 31, 2020 and December 31, 2019 and the related statements of income and cash flows (or the equivalent) for the fiscal years then ended; and (ii) the unaudited balance sheet of the Company as of ___ __, 2022 and the related statements of income and cash flows (or the equivalent) for the ___ month period then ended. Each of the financial statements referenced above (including in all cases the notes thereto, if any), fairly presents the financial condition of the Company as of the respective dates thereof and the operating results of the Company for the periods covered thereby and has been prepared in accordance with GAAP consistently applied throughout the periods covered thereby, subject, in the case of the foregoing clause (ii), to the absence of footnote disclosures (none of which footnote disclosures would, alone or in the aggregate, be materially adverse to the business, operations, assets, liabilities, financial condition, operating results, value, cash flow or net worth of the Company). 

The critical language of the financial statement representation is the “fairly presents” phrasing, i.e., that the financials “fairly present the financial condition of the Company as of the respective dates thereof and the operating results of the Company for the periods covered thereby.” The “fairly presents” standard track corresponding language within unqualified audit reports under U.S. generally accepted accounting principles (GAAP).

As a result, the seller's financial statement representation, using this language, should mirror, in large part, the audit report given to the seller by its auditors, assuming the auditors provided an unqualified report regarding the financial statements covered by the seller's representation. As a related point, assuming the seller's auditor report and the financial statement representation use the same standard and language, it's possible that the seller may have a claim against its auditors in the event of a breach of the financial statement representation—depending on any limitations on liability agreed to between the seller and the auditor and other relevant facts.

Many financial statement representations also include a materiality qualifier that qualifies the fairly presents language. For example, the representation may state that the financial statements “fairly present in all material respects the financial condition ...”

Every other year since 2005, the ABA has released its Private Target Mergers and Acquisitions Deal Points Studies. The ABA studies examine purchase agreements of publicly available transactions involving private companies. These transactions range in size but are generally considered as within the “middle market” for M&A transactions; the transaction values of the 108 deals within the 2023 study ranged from $30 to $750 million.

As reflected in the ABA studies, financial statement representations are consistently seen in all, or almost all, M&A purchase agreements. All ten ABA studies, other than the 2011 study, showed financial statement representations in 97% or more of reported transactions.

Although financial statement representations are quite common, related concepts are often more intensely negotiated between buyer and seller, including:

GAAP Qualification . One common discussion point between buyer and seller is whether or not the representation should be GAAP-qualified.

Books and Records . Apart from, though related to, the financial statement representation, is the “books and records” representation, whereby buyers seek assurances as to the accuracy and completeness of the target's books and records.

Financial Statement Component Representations . In addition to the financial statement representation, the buyer may ask for separate representations relating to specific components of the target's balance sheet. Specifically, the buyer most often seeks representations regarding the target's accounts receivables, inventories, and fixed assets.

These three concepts, discussed individually in more detail below, are often set forth in different representations and/or locations within the M&A purchase agreement. Further, the importance of and interrelationship among these concepts are not always fully appreciated, especially among entrepreneur owner-managers and other similar sellers who have never experienced a sale or recapitalization. But for many buyers, not all seller representations are of equal import: representations tied to seller financial statements are often considered amongst the most meaningful and significant to a buyer.

GAAP Qualification

Whether the fairly presents language in the financial statements representation should be GAAP-qualified often generates significant discussion between the parties. Including such a GAAP qualifier may provide more reliability of interpretation since, as noted above, the fairly presents standard has a meaning under GAAP. In addition, GAAP often allows for flexibility in how accounting determinations are made. Consequently, a fairly presents representation not qualified by GAAP creates uncertainty that may broaden the scope of a buyer's potential claims if the seller breaches the financial statement representation.

While the issue of whether the financial statement representation should be GAAP-qualified seems straightforward, in practice it is frequently misunderstood. For example, the financial statement representation may include a reference to GAAP compliance as an additional concept but not as a qualifier to the “fairly presents” statement. This seemingly small distinction may result in very different outcomes. The somewhat lengthy financial statement representation quoted above references GAAP but it is not a GAAP-qualified representation. Rather, that representation states that the financial statements fairly present, etc., “and have been prepared in accordance with GAAP consistently applied throughout the periods covered thereby.” The GAAP statement in this representation is separate from and does not qualify the “fairly presents” language.

It is perhaps easier to highlight the distinction using the shorter example representations cited in the 2013 ABA study referencing the ABA Model Asset Purchase Agreement. This example, which is similar to the example above, includes a GAAP component but is not considered GAAP-qualified.

The Financial Statements (i) fairly present the consolidated financial condition and the results of operations, changes in shareholders' equity, and cash flows of the Company and its Subsidiaries as at the respective dates of, and for the periods referred to in, the Financial Statements, and (ii) were prepared in accordance with GAAP, subject, in the case of the Unaudited Financial Statements, to normal recurring year-end adjustments.

As with the longer example, the GAAP reference in this representation is separate and in addition to the “fairly presents” representation, and does not qualify that representation. 

An example cited in the 2017 ABA study of a financial statement representation that is GAAP-qualified reads:

The financial statements fairly present (and the financial statements delivered pursuant to Section 5.8 will fairly present) the financial condition and the results of operations, changes in shareholders' equity and cash flows of [Target] as at the respective dates of and for the periods referred to in such financial statements, all in accordance with GAAP.

Unlike the previous examples, the statements in this representation are all qualified by GAAP. That is, GAAP compliance is not a separate, independent statement but rather operates as a qualifier to the whole. The inclusion of a GAAP qualifier on the otherwise unqualified and broad fairly presents language of a typical financial statement representation generally makes the representation more seller-friendly. Although sellers may negotiate for the inclusion of such a qualifier, according to data from the ABA studies, GAAP-qualified financial statement representations are present in less than one-quarter of reported transactions. The chart below shows the trends with respect to this issue. 

Books & Records Representations

In addition to the financial statement representation, buyers often request a “books and records” representation. Such representation may read:

The books and records and other financial records of the Company, all of which have been made available to the Buyer, are complete and correct and represent actual, bona fide transactions and have been maintained in accordance with sound business practices.

Some books and records representations may also include statements regarding the accuracy and completeness of the company's minute books. A buyer seeking a books and records representation may argue that the company's books and records are the underlying basis for its financial statements, and if those books and records are inaccurate, the financial statements may be defective notwithstanding the financial statement representation. See A.B.A. Model Asset Purchase Agreement, §3.5 & cmt. (2001).

On the other hand, the seller could counter that the financial statement representation should stand on its own and provide the buyer sufficient comfort while using an established fairly presents standard. In addition to the seller arguments against giving such a representation, private sellers, particularly smaller or closely-held companies, often have lapses in their record keeping and are simply unable to represent that its books and records are complete and correct.

Financial Statement Component Representations

Even with a financial statement representation, a buyer may still seek additional representations regarding specific components of the company's balance sheet. Normally, these additional representations address the company's accounts receivables, inventory, and fixed assets. Examples of these representations may read:

Receivables: All accounts receivable reflected on the Latest Balance Sheet and all accounts receivable to be reflected on the Closing Statement (net of allowances for doubtful accounts as reflected thereon and as determined in accordance with GAAP consistently applied) (the “Accounts Receivable”) are or will be bona fide accounts receivable owing to the Company and arising in the Ordinary Course of Business, and are not subject to offset or reduction for any reason. Except as set forth on Schedule X, no Person has any Lien on Accounts Receivable or any part thereof, and no agreement for rebate, deduction, free goods, discount or other deferred price or quantity adjustment has been made with respect to any such Accounts Receivable.

Inventory. All of the Company's Inventory consists of a quantity and quality usable and salable in the Ordinary Course of Business, which is and will be merchantable and fit for its intended use, subject only to the reserves for Inventory writedowns or unmarketable, obsolete, defective or damaged Inventory reflected in the Latest Balance Sheet and the Closing Statement, both as determined in accordance with standard past practices of the Company. The Company has not sold, assigned, transferred, leased, licensed or otherwise encumbered any of its Inventory, except in the Ordinary Course of Business.

Fixed Assets. Schedule Y sets forth all of the Fixed Assets owned, leased or held by the Company, and sets forth, as to such Fixed Assets, the original purchase price and total accumulated depreciation. Each material Fixed Asset, and all Fixed Assets in the aggregate, are in reasonable operating condition, normal wear and tear excepted.

A seller may assert that these representations are unnecessary and over-reaching because the financial statement representation includes these components within the fairly presents standard. Additionally, if the purchase agreement has a purchase price adjustment based on working capital, which is common, a seller may also argue that the working capital adjustment would pick up any issues with accounts receivable and inventory, though not fixed assets, as current assets within working capital.

If the seller agrees to an accounts receivable representation, it often resists any statement guaranteeing the collectability of the company's receivables, although not included in the example above, buyers often ask for such a collections guarantee. A buyer may counter that the fairly presents standard of the financial statement representation is broad and unfocused as to any particular assets. Thus, at a minimum, the seller should give separate representations as to accounts receivable and inventory, because those assets, as current assets, are sufficiently.

In practice, sellers often get comfortable providing a fixed asset representation similar to the above, and separate accounts receivable and inventory representations are not uncommon, though inclusion of collectability guarantees within the receivables representation is more the exception than the rule.

Financial statement and related representations can be tricky for M&A lawyers given the intersection between legal and accounting concepts. The facts and circumstances of a particular transaction will impact whether GAAP-qualifications, books and records representations, or balance sheet component representations are appropriate.

Click here for a pdf of the article.

Reproduced with permission from Bloomberg Law. Copyright ©️2024 by The Bureau of National Affairs, Inc. (800-372-1033)  http://www.bloomberglaw.com .

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ACCA FR Syllabus A. The Conceptual And Regulatory Framework - Faithful Representation - Notes 3 / 8

Faithful representation: It's much more than verification

Two of our prior columns critiqued the Financial Accounting Standards Board's recent preliminary views document on its new Conceptual Framework project, which, like many other FASB efforts, is a joint undertaking with the International Accounting Standards Board.Those columns examined the boards' take on financial reporting objectives and relevance, both of which are basically enhanced versions of FASB's first framework from the 1980s. While we see some improvement, we wish that the boards had pushed the envelope further and set the stage for more reformation in practice.

This column focuses on faithful representation, which occupies the place held by reliability in the original framework. The new basic definition of faithful representation is the "correspondence or agreement between the accounting measures or descriptions in financial reports and the economic phenomena they purport to represent." (Par. BC2.28)

That is, a measure is a faithful representation if it is a dependable depiction of what is being described in the financial statements. The original framework broke reliability down into the sub-qualities of representational faithfulness, verifiability and neutrality, where representational faithfulness included both completeness and freedom from bias. This time, FASB and the IASB propose that "a faithful representation of ... economic phenomena ... must be verifiable, neutral and complete." (Par. QC16)

While the name of the concept has changed, the underlying nature of the whole package shows that the other changes are slight. We found the situation to be like a newspaper puzzle that challenges you to find subtle differences between two very similar drawings. Because it's hard to find the differences, one might wonder why the boards changed the name. We think it was more than semantics.

WHAT'S IN A NAME?

Specifically, the boards wanted to avoid measurement arguments that used to hang upon the meaning of "reliability." The boards describe their rationale as follows: "In considering the issues related to ... reliability, as well as standard-setters' experience with assessing reliability, the boards observed the existence of a variety of notions of what the concept means. For example, some constituents focus on verifiability to the virtual exclusion of the faithful representation aspect of reliability." (Par. BC2.26)

There you have it - they tossed reliability out simply because too many people refused to understand its precise meaning in the framework.

Instead, many firmly clung to the familiar but invalid idea that reliability only means "subject to verification." These people think that a financial depiction is reliable if it can be verified by another person. Despite attempts over the years to convince them otherwise, the boards concluded that it's better to start over by renaming the overarching concept and then help others see that verification is only one facet of the package.

The boards' document defends the renaming decision by saying that "further efforts to explain what reliability means did not seem likely to be productive." (Par. BC2.27)

VERIFICATION ISN'T ENOUGH

There are several important points about faithful representation and its relationship to relevance, the other highest-level qualitative characteristic.

To begin, the boards insist that faithfulness is much more than simple verification. For example, a doublecheck of a depreciation schedule may verify that its calculations are correct, but does nothing to verify the more important proposition that the resulting book values actually provide faithful representations of the assets' future cash flows.

In other words, it does no good to validate numbers that do not describe the reporting company's cash-flow potential. Now that the proposed framework clearly states that relevance is based on helping users evaluate future cash flows, many traditional measures, especially any that involve systematically allocated historical costs, have no real possibility of being faithful representations of that potential. If a measure does not faithfully represent the magnitude of the assets' and liabilities' potential cash flows, there can be no usefulness in it, no matter how many people verified the supporting calculations.

WHO'S ON FIRST?

The preliminary views document wisely stays away from the unwinnable game of arguing whether relevance or faithful representation is more important. Not even Solomon could resolve that issue, because both qualities are inextricably linked and necessary for information to have decision-usefulness.

Despite this interrelationship, the document clearly states that relevance should be addressed first: "If information about a particular real-world economic phenomenon is not pertinent to investment or credit decisions, none of the other qualitative characteristics matter. Accordingly, it would be inefficient to consider faithful representation, comparability or understandability for irrelevant items." (Par. BC2.62)

Because the set of relevant measures is much smaller than the set of faithful representations, the most efficient screening process begins by identifying relevant numbers and then assessing their faithfulness.

VERIFYING VERIFIABILITY

Once relevance is settled and it's determined that a proposed measure reflects the relevant attribute's magnitude, then the next test is for its verifiability. The document explains more about verification by identifying two different ways of accomplishing it. Specifically, information can be verified directly by actually repeating the original process, or it can be verified indirectly by determining that the original process is appropriate. Either approach works to confirm the result's validity.

WHAT'S MISSING?

While the boards' discussion makes it clear that verification is not enough, it's disappointing that the other components of faithful representation don't include a key point. As mentioned earlier, the proposal identifies three sub-qualities of faithfulness: verification, neutrality and completeness. We have no problem with these three, but we regret the omission of the idea of congruence of the verified measure with the relevant attribute's real magnitude.

For example, if an asset's market value were $25 million, then a reported number would be faithful only if it's close to that. (Other terms that could be used for this quality might be validity - or accuracy.) Leaving out congruence as a specific component of faithful representation leaves the door wide open for someone to claim that it really isn't that important, despite what is said elsewhere in the framework.

We think including a separate component for congruence is crucial to making it clear that verifiable measurement methods are worthless if their results don't correspond to reality.

WRAPPING UP

We hope that the new framework will elevate understanding of faithful representation, so that people fully comprehend that little is achieved by simply checking off others' work. We are especially pleased that the new framework will clarify that relevance and faithful representation are both essential, thereby discrediting those who cling to verifiability as justification for historical cost-based measures. The new terminology will make it difficult for opponents of market value reporting to find traction with their old arguments.

Our optimism is promoted by several recent FASB decisions that have achieved real progress in giving users the kind of information they sought, but that was adamantly opposed by others in the past. Specifically, users can now easily find facts about options expense and pension obligations right there in the statements; in addition, the board has given its blessing to expanded market value accounting in many situations.

The board's resolute moves despite strong opposition tell us that the proposed changes in the framework are likely to become official. And that's good news for everyone, although not everyone will see it that way.

Paul B. W. Miller is a professor at the University of Colorado at Colorado Springs and Paul R. Bahnson is a professor at Boise State University. The authors' views are not necessarily those of their institutions. Reach them at [email protected].

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FDD Item 19 Financial Performance Representations

What Is an Item 19 Financial Performance Representation?

A financial performance representation is any written or oral statement or communication made by a franchisor to a franchisee or the public about the actual or potential financial performance of a franchised business. If a franchisor elects to make a financial performance representation it must be disclosed in Item 19 of the Franchise Disclosure Document and must comply with the disclosure requirements of the Federal Franchise Rule and, at the state level, NASAA and NASAA's Commentary for Financial Performance Representations .

The definition of what qualifies as and constitutes a financial performance representation is broad and includes historical data, projections, and pro-formas. Under the Federal Franchise Rule, financial performance representations are defined as: " Any representation, including any oral, written, or visual representation, to a prospective franchisee, including a representation in the general media, that states, expressly or by implication, a specific level or range of actual or potential sales, income, gross profits, or net profits. The term includes a chart, table or mathematical calculation that shows possible results based on a combination of variables."

How Does the Issue of Item 19 Financial Performance Representations Come Up During the Franchise Sales Process?

In the ordinary course of the franchise sales process, prospective franchisees will ask questions about the actual or potential financial performance of the franchised business. Questions like:

"What do your numbers look like?"

"What is the gross revenue for your corporate location?"

"What do you take home?"

"Can you help me project my revenues and earnings as a franchisee?"

"What should I estimate my revenues to be in years one, two, three, etc…?"

"What profit margin should I expect?"

"Can you give me a pro forma worksheet to estimate my revenues and profit?"

How you address and answer these questions and, whether or not your FDD includes Item 19 financial performance representations will play a major role in your franchise sales process. From a franchise sales perspective, they provide prospective franchisees with important validating factors and metrics for comparison with competing franchise brands. Franchise brokers are also extremely interested in financial performance representations and typically favor brands that disclose their data. From a legal perspective, including a financial performance representation helps to insulate a brand from false franchisee claims, i.e. , where a franchisee claims that although the FDD did not include a financial performance representation the franchisor's sales agent orally disclosed information.

What Is the Rule About Item 19 Financial Performance Representations When Selling Franchises?

The rule is that as a franchisor you cannot make a financial performance representation unless the financial data is stated and contained in FDD Item 19. If your FDD does not include Item 19 financial performance representations, you cannot, under any circumstance, publicly disclose or provide franchisee candidates with financial performance data or information. This restriction will apply to you directly and to all agents that are involved in the franchise sales process, including sales agents, brokers, and other franchise sellers.

All Item 19 financial performance representations must comply with the federal franchise rule, state rules, and NASAA Franchise Registration and Disclosure Guidelines, including the financial performance representation commentary adopted on May 8, 2017.

FDD Item 19

FDD Item 19 is the section of the Franchise Disclosure Document where franchisors must disclose their financial performance representations. If a franchisor elects to make a financial performance representation, it must be fully disclosed in Item 19 and must comply with federal and state franchise laws .

During the course of the franchise sales process franchisors cannot provide financial information that goes beyond the exact disclosures contained in Item 19. The restrictions related to financial performance representations relate to direct communications with franchisee candidates and, also, advertisements and public information disclosed by a franchisor. Within the franchise registration states , state regulators review and evaluate financial performance representations to determine whether or not the nature and the type of Item 19 disclosure made by a franchisor conforms to federal and state specific requirements.

What Type of Information Is Typically Disclosed in an Item 19 Financial Performance Representation?

Financial performance representations are typically based on historical financial data focused on the gross sales and income achieved by corporate and franchised outlets during the most recently completed calendar year. At a baseline level, the most common financial information reported by franchisors relates to "Gross Sales" followed by "Cost of Goods Sold," "Gross Profit," and, in certain instances, EBITDA, and KPI driven sales and customer data. Although permitted under the franchise rules, franchisors rarely report pro-forma financial data as the requirements for reporting pro-forma data is stringent and requires a detailed foundation of assumptions and underlying data. Although there are many legal and compliance issues that must be reviewed, as a franchisor, you have a good amount of flexibility in developing your Item 19.

What is the Legal Standard Developing Item 19 Financial Performance Representations?

As a franchisor, you must ensure that you have a "reasonable basis" for the information and representations made in your FDD Item 19 financial performance representations. You must also maintain written documentation and records that substantiate your Item 19 claims and demonstrate your reasonable basis. Prospective franchisees may request this documentation. The information reported in your financial performance representation does not need to be audited. Once disclosed, as a franchisor, you must ensure that the data and information underlying your Item 19 is and remains accurate and without any material omissions. If there is any change in the operations of the franchised business, the accuracy or facts underlying the bases of your financial performance representations, or economic changes that render your data misleading, you must immediately amend and update your FDD and Item 19.

What If You Don't Make an Item 19 Financial Performance Representation?

There are many reasons why you may not be able to make a financial performance representation. Some reasons may include the inability to document or verify your information, or inconsistencies that may exist between your internal data and other reported data. Although it is always better to have a quality financial performance representation, many start-up and established brands do not make Item 19 financial performance representations and still achieve significant franchise sales.

If you do not make an Item 19 financial performance representation, you must disclose the following disclaimer in FDD Item 19:

We do not make any representations about a franchisee’s future financial performance or the past financial performance of company-owned or franchised outlets. We also do not authorize our employees or representatives to make any such representations either orally or in writing. If you are purchasing an existing outlet, however, we may provide you with the actual records of that outlet. If you receive any other financial performance information or projections of your future income, you should report it to the franchisor’s management by contacting […], the Federal Trade Commission, and the appropriate state regulatory agencies.

The impact of not including an Item 19 financial performance representation will depend on your internal sales team, your business, the industry that you operate in, and whether or not your competitors include Item 19 financial performance representations in their FDDs.

Can You Include Disclaimers in Your Item 19 Financial Performance Representations?

You can, but the disclaimer that you may use is extremely limited. Under NASAA guidelines, you may use only one of the following two disclaimers and nothing more:

• For historical representations: "Some [outlets] have [sold] [earned] this amount. Your individual results may differ. There is no assurance that you’ll [sell] [earn] as much."
• For projections: "These figures are only estimates of what we think you may [sell] [earn]. Your individual results may differ. There is no assurance that you’ll [sell] [earn] as much."

To learn more about financial performance representations, and how we can help develop, review and improve the Financial Performance Representations in your FDD contact our team at (800) 976-4904 or click the button below.

Get the guide.

Read more about Item 19: Financial Performance Representations in our Planning Guide

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What Is Financial Modeling?

Understanding financial modeling, the bottom line.

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Financial Modeling: Definition and Uses

Financial modeling is the process of creating a summary of a company's expenses and earnings in the form of a spreadsheet that can be used to calculate the impact of a future event or decision.

A financial model has many uses for company executives. Financial analysts most often use it to analyze and anticipate how a company's stock performance might be affected by future events or executive decisions.

Key Takeaways

• Financial modeling is a numerical representation of some or all aspects of a company's operations.
• Financial models are used to estimate the valuation of a business or to compare companies to their industry competitors.
• Various models exist that may produce different results. A model is only as good as the inputs and assumptions that go into it.

Investopedia / Michela Buttignol

Financial modeling is a representation in numbers of a company's operations in the past, present, and forecasted future. Such models are intended to be used as decision-making tools. Company executives might use them to estimate the costs and project the profits of a proposed new project.

Financial analysts use them to explain or anticipate the impact of events on a company's stock, from internal factors such as a change of strategy or business model to external factors such as a change in economic policy or regulation.

Financial models are used to estimate the valuation of a business or to compare businesses to their peers in the industry. They are also used in strategic planning to test various scenarios, calculate the cost of new projects, decide on budgets, and allocate corporate resources.

Examples of financial models may include discounted cash flow analysis, sensitivity analysis , or in-depth appraisal.

One of the most frequently-used models is the discount cash flow model , which uses estimates of future cash flows to project the future value of an investment.

Example of Financial Modeling

The best financial models provide users with a set of basic assumptions. For example, one commonly forecasted line item is sales growth. Sales growth is recorded as the increase (or decrease) in gross sales in the most recent quarter compared to the previous quarter. These are the only two inputs a financial model needs to calculate sales growth.

The financial modeler creates one cell for the prior year's sales, cell A, and one cell for the current year's sales, cell B. The third cell, cell C, is used for a formula that divides the difference between cells A and B by cell A. This is the growth formula. Cell C, the formula, is hard-coded into the model. Cells A and B are input cells that can be changed by the user.

In this case, the purpose of the model is to estimate sales growth if a certain action is taken or a possible event occurs.

Of course, this is just one real-world example of financial modeling. Ultimately, a stock analyst is interested in potential growth. Any factor that affects or might affect that growth can be modeled.

Also, comparisons among companies are important in concluding a stock purchase. Multiple models help an investor decide among various competitors in an industry.

What Is Financial Modeling Used for?

A financial model is used for decision-making and financial analysis by people inside and outside of companies. Some of the reasons a firm might create a financial model include the need to raise capital, grow the business organically, sell or divest business units, allocate capital, budget, forecast, or value a business.

What Information Should Be Included in a Financial Model?

To create a useful model that's easy to understand, you should include sections on assumptions and drivers, an income statement, a balance sheet, a cash flow statement, supporting schedules, valuations, sensitivity analysis, charts, and graphs.

What Types of Businesses Use Financial Modeling?

Professionals in a variety of businesses rely on financial modeling. Here are just a few examples: Bankers use it in sales and trading , equity research, and both commercial and investment banking, public accountants use it for due diligence and valuations, and institutions apply financial models in private equity, portfolio management, and research.

How Is a Financial Model Validated?

Errors in financial modeling can cause expensive mistakes. For this reason, a financial model may be sent to an outside party to validate the information it contains. Banks and other financial institutions, project promoters, corporations seeking funds, equity houses, and others may request model validation to reassure the end-user that the calculations and assumptions within the model are correct and that the results produced by the model are reliable.

Financial modeling is a set of numerical techniques used to forecast a company's future growth. Based on the information in a company's income statement, balance sheet, and estimates of future economic conditions, analysts can create sophisticated projections of an investment's future performance.

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