Financial Statements Analysis
The purpose of financial statement analysis is to evaluate the financial performance and position of a company and define its strengths and weaknesses by analysing past and current records of its financial activities. The major benefit of financial statements analysis is that the investors get enough idea to decide about the investments of their funds in the specific company. They are prepared to meet external reporting obligations and for decision making purposes by estimating future risks and potential based on company’s trends and relationships. Financial analysis consists of an examination of financial statements of the company. This includes notes to the financial statements that explain the accounting policies of the company and provide details of how those policies were applied along with supporting details. The examination also includes the auditor's report which indicates whether audited financial fairly present the company's financial position in accordance with generally accepted accounting standards. The information provided in the financial statements is not an end in itself as no meaningful conclusions can be drawn from these statements alone. The information provided in the financial statements can produce meaningful insights about a company's financial information and its prospects for the future and can be used in making decisions through analysis and interpretation of financial statements.
Asset, liability, revenue and expense in Islamin Banks
The general conceptual framework for the financial statements of Islamic banks is, by nature, different from that of conventional financial institutions. Accounting concepts such as asset, liability, revenue and expense may have specific grounds.
An asset is any item of economic value which could be converted to cash or have other economic benefits. The asset side of an Islamic bank balance sheet may include various instruments with different maturities and risk-return profiles. There are assets resulting from short-term trade financing such as Murabahah and Salam; assets resulting from medium term investments such as Ijarah and Istisna’a; and assets resulting from long-term investments such as Musharakah. For an amount to be recognised as an asset in the balance sheet it should first be recognized as valid from the Shari’ah point of view and the bank must be able to obtain benefit from it and control the access of others to it.; assets as interest receivable in conventional balance sheets are not considered as asset in Islamic banks’ balance sheets. The asset should also be capable of financial measurement with a reasonable degree of reliability and should not be associated with an obligation or a right to another party. Liabilities are obligation arising from a transaction or other event that has already occurred and that involve the Islamic bank in a probable future transfer of cash, goods or services, or the forgoing of a future cash receipt, the date of which and the settlement of which are measurable with reasonable accuracy (Regulation and Supervision, Corporate Governance and Financial Accounting of Islamic Banks; IIBI; 2009). Even an obligation that is not valid from the Islamic point of view should be considered as a liability to the Islamic banks. By the nature of the investment accounts of an Islamic bank, they are not considered as liabilities as they are in conventional banks, because depositors of these accounts in Islamic banks are similar to partners whereas depositors in a conventional bank create immediate claims on the bank. The gross increase in assets or decrease in liabilities, during the period covered by the income statement, represent the revenues resulting from legitimate investment, trading and other profit-oriented activities of the Islamic bank. These revenues should not be the result of investment by owners, deposits by investment account holders, deposits by current account holders or the disposal of assets. On the other hand, the gross decrease in assets or increase in liabilities, during the period covered by the income statement, represents the expenses resulting from legitimate investment, trading and other activities of the bank, including delivery of services. These expenses should not be the result of distribution of dividend to owners, withdrawals by current account holders, withdrawals by owners or investment account holders or acquisition of assets.
An asset is any item of economic value which could be converted to cash or have other economic benefits. The asset side of an Islamic bank balance sheet may include various instruments with different maturities and risk-return profiles. There are assets resulting from short-term trade financing such as Murabahah and Salam; assets resulting from medium term investments such as Ijarah and Istisna’a; and assets resulting from long-term investments such as Musharakah. For an amount to be recognised as an asset in the balance sheet it should first be recognized as valid from the Shari’ah point of view and the bank must be able to obtain benefit from it and control the access of others to it.; assets as interest receivable in conventional balance sheets are not considered as asset in Islamic banks’ balance sheets. The asset should also be capable of financial measurement with a reasonable degree of reliability and should not be associated with an obligation or a right to another party. Liabilities are obligation arising from a transaction or other event that has already occurred and that involve the Islamic bank in a probable future transfer of cash, goods or services, or the forgoing of a future cash receipt, the date of which and the settlement of which are measurable with reasonable accuracy (Regulation and Supervision, Corporate Governance and Financial Accounting of Islamic Banks; IIBI; 2009). Even an obligation that is not valid from the Islamic point of view should be considered as a liability to the Islamic banks. By the nature of the investment accounts of an Islamic bank, they are not considered as liabilities as they are in conventional banks, because depositors of these accounts in Islamic banks are similar to partners whereas depositors in a conventional bank create immediate claims on the bank. The gross increase in assets or decrease in liabilities, during the period covered by the income statement, represent the revenues resulting from legitimate investment, trading and other profit-oriented activities of the Islamic bank. These revenues should not be the result of investment by owners, deposits by investment account holders, deposits by current account holders or the disposal of assets. On the other hand, the gross decrease in assets or increase in liabilities, during the period covered by the income statement, represents the expenses resulting from legitimate investment, trading and other activities of the bank, including delivery of services. These expenses should not be the result of distribution of dividend to owners, withdrawals by current account holders, withdrawals by owners or investment account holders or acquisition of assets.
Risks to disclose in financial statements
Given the popularity of Islamic financial products as an alternative banking platform and the increasing number of risks that Islamic financial institutions now take, they are obliged to be transparent by making adequate disclosures to their financial statements. In addition, Shari’ah compliance risk that should absolutely be taken into account IFIs, other types of risks should be included into their financial statements. In that sense, the AAOIFI has issued guidelines for accounting standards taking into consideration prudential rules to reflect the specific risk characteristics of Islamic financial contracts. The AAOIFI has also clarified the assessment of disclosures with regard to credit, market and liquidity.
Due to the high proportion of investments in equities in the financial position of Islamic Financial institutions, AAOIFI standard gives an particular attention to the disclosure of Investment / Market Risk by including in the financial statements of IFIs various information regarding the classification of securities, their market value and the movement in provisions for these securities. In the case of Mudarabah, disclosure may include an explanation of the reason for not giving fair value, principal characteristics of the investment, and information about the market for such investment. Regarding credit risk, AAOIFI standard require that general disclosure in the financial statements of IFIs cover information on concentration of assets risks by economic sectors and geographical areas, distribution of assets in accordance with their maturity and disclosure of related party transactions. Disclosure regarding Murabahah sales receivables focuses on the maturity profile of assets and liabilities, by separating the bank’s own assets from the assets managed for investment account holders. This would facilitate the identification of maturity mismatches, and thus the estimation of liquidity risk taken by the financial institution. The disclosure with regard to Liquidity Risk is another important point despite the fact that liquidity of IFIs is generally good because of the concentration of their financing operations in self-liquidating short-term Murabahah financing and commodity backed placements with banks (Regulation and Supervision, Corporate Governance and Financial Accounting of Islamic Banks; IIBI; 2009). And despite some concerns regarding their macro level liquidity in the event of financial distress due to their refusal of interest, most Islamic banks are keeping compensating balances with other commercial or central banks, to meet urgent liquidity needs of the respective counterparties. Furthermore, Islamic banks are subject to operational risk due to the particularities of their contracts and the general legal environment where they operate. In fact, there are also potential difficulties in enforcing Islamic contracts in a broader legal environment and potential costs and risks of monitoring equity-type contracts and the associated legal risks. For example, there is a cancellation risk in the non-binding Mudarabah and Istisna’a contracts. There is also a risk due to the need to maintain and manage commodity inventories often in illiquid markets. And any failure of the internal control system to detect and manage potential problems in the operational processes and back-office functions could affect the banks activity.
Due to the high proportion of investments in equities in the financial position of Islamic Financial institutions, AAOIFI standard gives an particular attention to the disclosure of Investment / Market Risk by including in the financial statements of IFIs various information regarding the classification of securities, their market value and the movement in provisions for these securities. In the case of Mudarabah, disclosure may include an explanation of the reason for not giving fair value, principal characteristics of the investment, and information about the market for such investment. Regarding credit risk, AAOIFI standard require that general disclosure in the financial statements of IFIs cover information on concentration of assets risks by economic sectors and geographical areas, distribution of assets in accordance with their maturity and disclosure of related party transactions. Disclosure regarding Murabahah sales receivables focuses on the maturity profile of assets and liabilities, by separating the bank’s own assets from the assets managed for investment account holders. This would facilitate the identification of maturity mismatches, and thus the estimation of liquidity risk taken by the financial institution. The disclosure with regard to Liquidity Risk is another important point despite the fact that liquidity of IFIs is generally good because of the concentration of their financing operations in self-liquidating short-term Murabahah financing and commodity backed placements with banks (Regulation and Supervision, Corporate Governance and Financial Accounting of Islamic Banks; IIBI; 2009). And despite some concerns regarding their macro level liquidity in the event of financial distress due to their refusal of interest, most Islamic banks are keeping compensating balances with other commercial or central banks, to meet urgent liquidity needs of the respective counterparties. Furthermore, Islamic banks are subject to operational risk due to the particularities of their contracts and the general legal environment where they operate. In fact, there are also potential difficulties in enforcing Islamic contracts in a broader legal environment and potential costs and risks of monitoring equity-type contracts and the associated legal risks. For example, there is a cancellation risk in the non-binding Mudarabah and Istisna’a contracts. There is also a risk due to the need to maintain and manage commodity inventories often in illiquid markets. And any failure of the internal control system to detect and manage potential problems in the operational processes and back-office functions could affect the banks activity.
