Financial statements are an accurate picture of a company’s financial affairs in a given year. They are prepared using financial information compiled by the firm’s accounting analysts. They must be reported in accordance with established and standardized accounting principles for compliance at all levels.
Financial statements are done systematically. They are a written summary of all ledger account amounts displayed to provide a clear view of a company’s financial position, profitability and performance.
They are prepared at the end of the accounting period, which is usually one year, and then audited by an auditor to verify their accuracy, transparency and fairness for tax and investment purposes.
Mastery of financial statements is the first step towards achieving business goals, whether you want to break into new markets, develop a new product or sell and move forward. This will have the numbers to back up the decisions.
What are financial statements for?
They are the means for organizations to reveal their story. There are four basic financial statements that all businesses must develop. Together, they reproduce an organization’s strength and profitability.
The balance sheet reveals the financial status and solvency of an organization. On the other hand, the statement of equity indicates the changes in retained earnings for a certain period, for example, a quarter or semester.
Although each financial statement is treated separately, they are all related. Changes in assets and liabilities that are seen on the balance sheet are also reflected in the income and expenses seen on the income statement, resulting in the company’s profit or loss.
Cash flows provide additional information about the cash assets listed on the balance sheet and are related to, but not equivalent to, the net income shown on the income statement.
– Aspects that contain
This is the information collected from accounting records. These accounts (debtors, cash account, fixed assets, creditors, etc.) are held at historical cost or original cost. The negotiable amount is not recorded.
The integration of such accounting principles makes the financial statement uniform, more reliable and also comparable.
Although assumptions and accounting principles must be followed, there are certain things that are left to the accountant‘s judgment: provisions for debts, deferral of expenses, method of calculating inventory (LIFO, FIFO, etc.). These accountant decisions will be reflected in the financial statements.
Importance of financial statements
These are complete reports on the health of the company, taking into account cash flow, revenue and balance.
Financial statements determine whether a company has the ability to pay back loans, whether it has the cash flow to service bills and buy stock. It will also tell you where the company is making money and where it is going.
They indicate whether the business is profitable, whether it will remain profitable, and whether major issues arise, such as a continued drop in sales over time.
Reading the financial statements will give you an overview of business conditions and if there are any warning signs of potential problems ahead.
A bank or other similar institution will consider financial statements as the first indicator of business performance and if further research is needed.
Characteristics of financial statements
The information provided by financial statements must be relevant to users’ requirements. While shareholders are the primary recipients of these statements, there are other stakeholders who rely on these statements during the decision-making process.
For example, institutions that provide funds (banks, finance companies, etc.), potential investors, vendors that are evaluating credit ratings, etc.
Therefore, the information provided in these financial statements must be relevant to the information needs of all these interested parties, as it may affect their decisions.
Financial statements are published to address the company’s shareholders. It is therefore important that they are prepared in such a way that they are easy to understand and interpret for shareholders. The information provided in these statements must be clear and legible.
To facilitate understanding, management should consider not only legal data, but also voluntary disclosures of information that would facilitate understanding of the financial statements.
Financial statements must be prepared in such a way that they are comparable to the previous year. This feature is very important to maintain as it ensures that the company’s performance can be monitored and compared.
This characteristic is maintained through the adoption of accounting policies and that the applied rules are consistent from one period to another and between different jurisdictions.
This allows users of financial statements to identify trends and patterns in the data provided, facilitating decision making.
The information provided in the financial statements must be reliable and true. Data obtained to prepare these financial statements must come from reliable and honest sources. They must represent a true and fair picture of the company’s situation.
This means that the information provided must not have any eloquent errors. Transactions shown must be based on the concept of prudence and represent the true nature of the company’s operations.
Critical areas and subjective nature should be presented with due care and with great appropriateness.
All information in the financial statements must be provided within an imperative period.
Disclosure should not be unreasonably delayed so that, when making economic decisions, users of these statements can have all relevant and up-to-date knowledge.
While this feature may require more resources, it is a vital feature as late information makes corrective reactions irrelevant.
Financial statements of a company
Financial statements are the combination of three reports about a business. They will contain the cash flow statement, income statement and balance sheet of the company. The three together produce an overall picture of the health of the business.
The main purpose of financial statements is to inform shareholders about the financial performance of the company. This is because the shareholders are the real owners of the company but the company is managed and managed by the directors. The objectives are:
– Determine the financial position, profitability and performance of the company.
– Determine cash inflows and outflows.
– Know the results of the commercial operations of the business.
– Provide information related to the company’s financial resources and obligations.
– Disclose accounting policies.
– Check the efficiency and effectiveness of the company’s management.
Preparation of financial statements
Each company will prepare financial statements to accompany year-end results in order to provide stakeholders with an overview of how the company is performing.
If a company is looking to increase credit lines with a bank or is trying to raise capital for an expansion, it will produce financial statements at the end of a fiscal quarter or the most recent month.
When preparing financial statements for these purposes, it is best practice to use general accounting language that is understood by all parties. A financial statement that might accompany a year-end report for employees to read is often familiar only to those involved.
Often, a government agency may request a financial statement for tax purposes. The company must produce a high quality one, using generally accepted guidelines.
A bank or investors may also request a financial statement without notice if they are concerned about the company’s profitability.
For this reason, it is essential for any organization to keep good, up-to-date records so that financial statements are quick and easy to produce.
Types of financial statements
Current assets include cash and cash equivalents, inventories, accounts receivable, etc. Equipment, vehicles, buildings, etc. are placed as non-current assets. A sequence is followed, from the most liquid to the least liquid lines.
On the other hand, current liabilities are considered promissory notes, accounts payable, taxes payable, outstanding salaries, etc. A non-current liability is considered long-term debt.
Accountants should ensure that total assets always equal total liabilities plus equity.
The income statement is about income and expenses. Start with revenue or gross sales. Then any return or sale discounts are deducted to get net sales.
From net sales, cost of goods sold is deducted to obtain gross profit.
Operating expenses, such as administrative expenses, are deducted from gross profit. By deducting operating expenses, earnings before interest and taxes (EBIT) is obtained.
EBIT deducts the tax and interest charges paid in the period, thus obtaining the net profit, which is the profit after taxes.
Cash flow statement
Cash flow from operations is the cash generated by the company’s main operations. Shows the use of cash for the operation of the organization.
Cash flow from investing activities has to do with cash inflows and outflows related to investments, such as the purchase of property, equipment or other investments.
Cash flow from financing activities is related to cash inflows or outflows corresponding to the company’s debts or assets. Includes collection of equity or debt, loan repayments, share repurchases, and others.
Statement of changes in equity
It is a financial statement that provides an overview of the change in equity over a given period.
Common stock is the most important component of equity. The common shareholders are the owners of the company.
When the company receives an award for the shares, it is called in additional equity.
Accumulated gains or losses roll over to the previous period. Retained earnings are the amount that the company retains after paying the dividend.
Treasury shares are the sum total of all common shares that the company has repurchased.
Examples of financial statements
Suppose you have the financial data for ABC Corp. to prepare several sample financial statements:
It summarizes a company’s revenues, expenses and costs incurred during a specific period.
The income statement is the one report that usually gets the most attention, as every company’s goal is to make a profit.
Net income is net income after deducting cost of goods sold, general expenses, interest and taxes.
It is a list of a company’s assets and liabilities as of a specific date. The equity portion contains all contributions from the company’s investors and retained earnings.
Cash flow statement
It summarizes cash and cash equivalents flowing in and out of an organization’s business operations. It differs from the balance sheet and income statement because it only records cash activities from operations.
Construction of the cash flow statement begins with the company’s earnings and then adjustments are made for changes in current assets, investing and financing activities.
Depreciation is an element that is not effective and is added back to net income on the statement of cash flows.