Understanding the Importance of Financial Statements

Financial statements are extremely important in assessing the standing of an enterprise in as much as financial data. They provide a systematic analysis of the financial statements and positions that are relevant concerning decision-making within the stakeholder’s firm. Regardless of the position of an organization: Be employed as a business owner or investor, manager or lender, these documents are helpful and outcome strategic management, the control of spending and financial forecasting. This article will describe what financial statements are, why they are useful, and which users’ requirements they satisfy.

What is a Financial Statement?

A financial statement can be defined as official documentation on the financial operations and place of business of a certain business entity or even an individual. It informs the reader about the financial position and specific financial profitability in a specified period. Decision making within any entity requires the use of financial statements as the tools perform important functions for determining the financial health and viability of a similarly important entity: stakeholders (in this context, investors, managers, creditors and regulators).

Businesses cannot neglect the importance of financial statements. As investors, regulators, and other stakeholders, we find them very important because they reveal a picture of a company’s finances and financial performance. They are the big determining factor in determining how stable, profitable, or potential a business is. Now, let’s take a further look at why financial statements are essential.

• Determines the company’s financial position: A big advantage of these statements is that they provide financial information and the company’s performance on a specific date. Such statements will assist in rational and strategic business decisions of business stakeholders and shareholders.

• Taxation and Reporting: You have to prepare the business taxes and to do that, you need the financial statements. Tax authorities also use them to determine whether a certain company has breached tax regulations.

• Helps investors in decision-making: These financial statements provide every piece of information an investor should know when investing. With this information, they can determine the price per share of an investment.

• Helps in getting credit: The financial statements provided in these provide all the information that one requires when making a decision to invest. With this information available, one can find out the cost per share of making investments.

• Financial statements help in getting credit: They let lenders know how much they can invest in a business. Additionally, they help them give extra credit for business expansion and measure the business’s ability to decline its debt.

• Investigates business transactions: The financial statements that an auditor or an accountant uses in investigating a particular business transaction are used to determine whether the facts are right.

Types of Financial Statements

There are several types of financial statements a company uses for various reasons.

Balance Sheets

Therefore, the balance sheet quantifies the firm’s financial position at a certain point in time by stating the quantity of assets, liabilities and shareholders’ equity. This one lets you learn about a company’s net worth and equity. Here are a few components of a balance sheet

• Assets: A resource for a company, which it owns or is otherwise controlled by, and which the company can turn to cash by selling. An organization may have an interest in the supply of physical assets (machinery and equipment, property and land, inventory, etc.) as well as trademarks, investments, patents, etc.

• Liabilities: Liabilities are generally defined as financial obligations or debts that might be issued by any person to anybody or any other entity. They have such future obligations, and they are to be repaid through currency, such as money, goods, or services.

The role of a financial account is very important. It helps to measure the business’s responsibility regarding financial liabilities recorded in the balance sheet.

• Shareholder’s equity: Corporate shareholders’ equity, in its simplest meaning, refers to the amount of money a firm has remaining at its disposal after all out-of-pocket expenses related to its actual or asserted liability have been incurred and all the tangible corporate assets are sold off. Net worth or value is the company’s worth or value.

Assets = liabilities + shareholder’s equity

Income Statement 

The Income Statement (also commonly known as the Profit and Loss Statement or P&L) is just one of the nice financial statements and is an economics speciality item which shows a business’s monetary functionality over a particular time period: either quarterly or yearly. It is a brief overview of a company’s income or revenue and the expenses and profits of that company during a specified period. By deducting expenses from the Income, we can find whether the company made a loss or profit in a particular accounting period.

• Revenue or sales: The sales or revenue forms the top line of an income statement.

• Operating expenses: Expenses that a business incurs to keep things running and doing business. The other kinds of expenses include rent, payroll taxes, depreciation, advertising and loans. .

• Non-operating expenses: This is something that has cost or expense and which in itself is not directly related to the line or core business of a business. For example, non-operating expenses include quantitative redundancies, loan interest paid and the amount spent for settlements of legal cases.

• Net income: Net income or net earnings or net profit, as the name suggests, is the ultimate figure of a company and assesses the profitability of the business. It’s the entire revenue a business earns from delivering products to consumers or providing services to a customer.

Net Income = revenue – expenses

Cash Flow Statements

A Cash Flow Statement is a financial statement that demonstrates the flow of cash within an organization over a specific period of time. Unlike the Income Statement and the accrual account ledger of revenues, expenses, and cash, the Cash Flow Statement comprises only exact cash-resulting transactions. It is divided into three main sections: operating activities, financing activities, and investing activities.

• Cash flows from core business operations, such as customer revenues and payments to suppliers and employees, are categorized as Operating Activities.

• Investing Activities reflect cash flows related to the purchase or sale of long-term assets like property, equipment, or investments.

• Financial Activities include cash flows related to the sale and purchase of the company’s shares or other borrowing undertaken by the company or repayment of the loans taken.

Also Read: Types of Cash Flow: Top 10 Terms You Must Know

Statements of Shareholder’s Equity

The balance sheet is an account of the shareholders’ equity. It is a financial statement that tells you how the shareholder’s equity value changed from one accounting period to another. It tells you what it is you do to know if the value of shareholders’ equity has grown or decreased. Here are some essential components of this statement:

• Preferred Stock: Like equity, preferred stock gives a holder a capital interest in the company, but unlike equity, it comes with priority to earnings. People who have common stock can vote in the company but don’t receive dividends before stockholders.

• Common Stock: Common stock is a type of ownership stake in a company that gives the holder voting rights.

• Retained Earnings: They are the undistributed accumulated profit of the business, which belongs to the business owner’s Equity section of the company’s balance sheet. The company retains them for reinvestment within the company.

• Treasury Stock: An issuing company repurchases a stock. Sometimes, a company will actually buy back its own stock to raise the stock price (that’s called boosting share price, which also keeps another company from buying it).

Conclusion

The main means of the measurement of the financial performance of the organizational conditioning are the financial statements. It is a detailed account of a company’s profitability, liquidity and solvency, therefore intimated as a strong proof of a company’s financial strength. The resulting income statement, balance sheet and statement of cash flows show how a company may generate income, control expenses, assign resources to assets and owe money to others.

Additionally, they promote corporate transparency, integrity and regulation compliance and promote credibility amongst shareholders and other market entities. Specifically, timely and accurate reporting of financial information is quite fundamental to how efficient operation of financial markets and an organization’s safe and sustainable growth. Want to learn more about finance and risk management? Try Hero Vired’s Certificate Program in Financial Analysis, Valuation, & Risk Management offered in collaboration with edX and Columbia University.