Financial statements are official documents used by businesses and corporations. It is used to summarise their activities and provide full details about their assets, liabilities, and capital.
Financial Statement Meaning
- A financial statement is a document that outlines the financial operations and position of an individual or company. It often discloses assets, liabilities, revenue, and expenses.
- Financial statements are used to monitor financial performance and inform future decisions.
- Financial statements act as a report card for a company or individual.
- They show the total amount of money received, spent, and remaining at the end. There are several types of financial statements, including the balance sheet, income statement, and cash flow statement.
Types of Financial Statements
1. Income Statement
An income statement is a financial statement that lists a company’s earnings, costs, profits, and losses for a given time period.
Purpose: It demonstrates if the company generated a profit or a loss during that time.
Uses: Income statements evaluate a company’s productivity, effectiveness, and creditworthiness.
Alternate name: A profit and loss statement, or P&L, is another name for it
2. Balance Sheet
A balance sheet is a financial statement that summarises a company’s financial position at a certain point in time.
Contents: We list assets, liabilities, and shareholder equity on a balance sheet.
Purpose: It gives a quick overview of the assets and liabilities of a firm as well as the amount of shareholder investment.
Uses: We use balance sheets in conjunction with other crucial financial data when doing basic analysis or calculating financial ratios.
3. Cash Flow Statement
A cash flow statement is a type of financial statement that details the cash inflows and outflows of a business from its operations, investments, and financing activities.
Purpose: Cash Flow Statement assesses a company’s strength, profitability, and forecast for the future, as well as its liquidity and budgeting issues.
Analysis: There are several approaches to analysing the cash flow of a business using different ratios and measures.
4. Adjustment for Equity
Changes in equity refer to the variations in a company’s equity ( hence, it shows the difference between assets and liabilities) across a reporting period.
Purpose: A statement of changes in equity compares the starting and closing equity balances and illustrates how the income statement and balance sheet are related to one another.
Examples: Net gain or loss, dividends, share issuances, changes in accounting principles, and error corrections are all examples of equity movements.
Key Principles of Financial Statements
1. Relevance of Financial Statements:
In financial reports, data is considered relevant, however, if it is valuable to the end- user and can help them make an appropriate decision.
Who are the End Users?
The end user can be internal, such as a manager or top executive, or external, such as a lender or potential financial backer.
Why is Relevance Important?
Financial statements are relevant when they contain data that is valuable enough to estimate or predict future events. Such as future cash flows, which investors will use to make informed decisions
2. Reliability of Financial Statements:
Reliability refers to the accuracy and trustworthiness of the financial data reported in a company’s financial statements.
The Reliability Principle:
The reliability principle, is also known as the objectivity principle. Hence, it has a key accounting principle that ensures that a company’s accounting statements and records contain the most accurate and objective information possible.
Why is Reliability Important?
Reliability is crucial for financial statement users, such as investors, lenders, and managers, who rely on the accuracy of the data present to make decisions.
Comparability in Accounting Information
When financial information is comparable. Certainly, it means that people can use it easily and understand it better.
- Standardisation: There is a level of standardisation in accounting information. Therefore it allows for comparisons between the accounts of different organisations.
- Preparation and Reporting: Comparable data is known to prepare using the same measurement methods. It reports similarly so that one can assess other comparable financial information side by side.
Understandability of Financial Information
Understandability refers to the ease with which financial information can be understood by the reader.
- User Knowledge: Financial information is understood by users of financial statements, for instance, if they have a good understanding of business and economic activity.
- True Representation: Financial information is seen as a true representation, however, if it is accurate, timely, and free from errors.
- Presentation: Financial information must be clear, concise, and complete in presentation.
Summary
A financial report is a formal record of a company’s financial activities and performance. There are four main types of financial statements: the balance sheet, income statement, cash flow statement, and statement of changes in equity. These statements are combination of recorded facts, accounting conventions, postulates, and personal judgments. While they provide valuable information to stakeholders, they do have certain limitations. Financial statements are used by a wide range of stakeholders to make informed decisions, evaluate performance, plan strategies, and allocate resources.
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