A financial statement (or financial report) is a formal record of the financial activities of a business, person, or other entity.
Relevant financial information is presented in a structured manner and in a form easy to understand. They typically include basic financial statements, accompanied by a management discussion and analysis:
A balance sheet, also referred to as a statement of financial position, reports on a company’s assets, liabilities, andownership equity at a given point in time.
An income statement, also known as a statement of comprehensive income, statement of revenue & expense, P&L orprofit and loss report, reports on a company’s income, expenses, and profits over a period of time. A profit and loss statement provides information on the operation of the enterprise. These include sales and the various expenses incurred during the stated period.
A statement of cash flows reports on a company’s cash flow activities, particularly its operating, investing and financingactivities.
Purpose of financial statements by business entities
“The objective of financial statements is to provide information about the financial position, performance and changes in financial position of an enterprise that is useful to a wide range of users in making economic decisions.” Financial statements should be understandable, relevant, reliable and comparable. Reported assets, liabilities, equity, income and expenses are directly related to an organization’s financial position.
Financial statements are intended to be understandable by readers who have “a reasonable knowledge of business and economic activities and accounting and who are willing to study the information diligently.” Financial statements may be used by users for different purposes:
Owners and managers require financial statements to make important business decisions that affect its continued operations. Financial analysis is then performed on these statements to provide management with a more detailed understanding of the figures. These statements are also used as part of management’s annual report to the stockholders.
Employees also need these reports in making collective bargaining agreements with the management, in the case of labor unions or for individuals in discussing their compensation, promotion and rankings.
Prospective investors make use of financial statements to assess the viability of investing in a business. Financial analyses are often used by investors and are prepared by professionals (financial analysts), thus providing them with the basis for making investment decisions.
Financial institutions (banks and other lending companies) use them to decide whether to grant a company with fresh working capital or extend debt securities (such as a long-term bank loan or debentures) to finance expansion and other significant expenditures.
Consolidated financial statements
Consolidated financial statements are defined as “Financial statements of a group in which the assets, liabilities, equity, income, expenses and cash flows of the parent (company) and its subsidiaries are presented as those of a single economic entity”, according to International Accounting Standard 27 “Consolidated and separate financial statements”, and International Financial Reporting Standard 10 “Consolidated financial statements”.
Government financial statements
The rules for the recording, measurement and presentation of government financial statements may be different from those required for business and even for non-profit organizations. They may use either of two accounting methods: accrual accounting, or cost accounting, or a combination of the two. A complete set of chart of accountsis also used that is substantially different from the chart of a profit-oriented business.
Audit and legal implications
Although laws differ from country to country, an audit of the financial statements of a public company is usually required for investment, financing, and tax purposes. These are usually performed by independent accountants or auditing firms. Results of the audit are summarized in an audit report that either provide an unqualified opinion on the financial statements or qualifications as to its fairness and accuracy. The audit opinion on the financial statements is usually included in the annual report.
There has been much legal debate over who an auditor is liable to. Since audit reports tend to be addressed to the current shareholders, it is commonly thought that they owe a legal duty of care to them. But this may not be the case as determined by common law precedent.
Standards and regulations
Different countries have developed their own accounting principles over time, making international comparisons of companies difficult. To ensure uniformity and comparability between financial statements prepared by different companies, a set of guidelines and rules are used. Commonly referred to as Generally Accepted Accounting Principles (GAAP), these set of guidelines provide the basis in the preparation of financial statements, although many companies voluntarily disclose information beyond the scope of such requirements.