Discussion Question Firm and Individual Financial Reporting.docx
1. Discussion Question : Firm and Individual Financial Reporting
In this activity, we link personal and corporate finance to understand why people
sometimes behave like corporations, and vice versa. We begin by asking why firms issue
financial statements. Firms that sell ownership shares to the public are required by law to
issue financial statements (see SEC, The Laws That Govern the Securities Industry), but
many other firms also publish similar financial information describing income, assets, and
liabilities. Individuals are asked to produce some of the same information as they apply for
loans and credit. In this Discussion, we think about the mortgage loan application process to
better illuminate information gleaned from a firms four key financial statements.
Similarities exist between documentation requested of an individual applying for a loan and
a firm accepting funds from investors. We explore why this may be true to understand the
key financial statements. Case Study:Juchengs Loan ApplicationYou are a loan offer at a
community bank. You are working with a client Jucheng, who is referred by Dave. Dave is a
friend of Jucheng, and Jucheng is now working with you to secure his first home loan. With
acceptance of Juchengs offer on a home, he must secure financing.Jucheng is currently
applying for a home loan while Dave applied recently. Differences in Dave and Juchengs
financial situations distinguish them as loan applicants. Both loan applicants are buying
homes of similar value and their income is similar.Juchengs Profile: Jucheng only recently
accepted employment offering stable income, something he has not had in the past. Jucheng
finds it harder to show a record of stable income and employment to meet income
documentation requirements. Juchengs income has historically been irregular. He
supplemented his earnings with the sale of imported Asian Medicinal products but revenues
from Juchengs supplemental income have also been historically irregular. Jucheng manages
each of his business enterprises as Sole Proprietorships. Family contributed funding. He
also has personal responsibility for business debts, including a business line of credit with
balances and payments that are high in relation to his business income. Juchengs amount of
savings is low.Daves Profile Dave has had a stable source of income and has not moved
between firms for many years. He has low debt in relation to his assets. Investments listed
on Daves mortgage loan application counterbalanced the liability of the mortgage loan. The
origin or his down payment is savings from past earnings, so his financial claim to these
funds is clear. He had made no major purchases in recent years and had no major changes in
his financial situation. Always having stable income, Dave pays his debts on time. His debt to
income ratio is low.From the perspective of the lender, Juchengs request for a loan is more
problematic than Daves because Jucheng is less able to document his income, assets, and
2. liabilities. The bank needs information to prove that a borrower is likely to repay a loan.
Investors considering investing in a firm are interested in similar issues.You are in a trusted
position, aiding community members seeking mortgages, but also assuring that interests of
savers of this small bank are safeguarded by your due diligence. You work closely with to
ensure documentation of consumer credit applications is in place at . You notice Jucheng is
new to the process guaranteeing a borrowers ability for repayment and general financial
stability. You are torn between empathy for Jucheng and an ethical regard for your fiduciary
duty as an agent for this small bank. As a loan officer you recognize that Jucheng has
difficulty documenting claims to his assets, including the origin of his down payment and his
income. You wonder how you will explain the disappointing news that Jucheng may not
qualify for a mortgage, even though he has enough income to cover payments
currently.Luckily, you are involved in a Financial Management course offering insight into
the four key financial statements and measures derived from them used by firms to justify
access to obtain capital markets. Using financial ratios derived from these statements as
illustrations, you thus explain to Jucheng the reasoning behind documentation of income
and earning ability, solvency, assets and debt, savings, and origins of assets that financial
statements offer investors.