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Accountancy > Financial Statements of a Company > Uses of Financial Statements and their Limitations
Financial Statements of a Company

Uses of Financial Statements and their Limitations

Financial statements of a company perform several important functions. Firstly, they reflect the true state of affairs of the company. They also help in taking important financial information. From shareholders and investors to government and creditors, many people use them. Let us understand some uses of financial statements.

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Uses of Financial Statements

1. Bridging the Gap in Management

Financial statements basically reflect a company’s financial performances. They show profits and liabilities of the business. They show how successful a company’s decisions have been. Since shareholders have access to these statements, they can gauge their company’s performance. This further helps in bridging the gap between lapses in management and expectations of owners.

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2. Availing Credit from Lenders

Every business needs to borrow funds for functioning. They have to rely on lenders like banks and financial institutions for this purpose. Financial statements play a huge role in this purpose. Since they show a company’s liabilities, debts and profits, investors can use them to make informed decisions.

3. Use for Investors

Investors also extensively use a company’s financial statements to asses its finances. That helps them figure out how the company’s solvency will be in the longer term. Thus, the better a company’s financial position is, the greater the investment it will receive.

4. Use for Government

Governmental policies pertaining to corporates depend heavily on financial statements. This is because these statements depict how companies are functioning in general. The government can use this information to decide taxation and regulatory policies.

5. Use for Stock Exchanges

Regulatory bodies like SEBI and stock exchanges like BSE and NSE also use financial statements for many reasons. SEBI can assess a company’s internal matters using them to ensure the protection of investors. Even stock advisers require them to frame their quotes. They are also a great source of information for stock traders and investors.

6. Information on Investments

The shareholders of a company rely on these statements to understand how their investments are paying off. If a company is earning profits, they might decide to invest even more money. On the contrary, stagnant profits or even losses will prompt them to pull out. Despite all these uses of financial statements, there are some limitations to them as well.

Uses of Financial Statements

Limitations of Financial Statements

1. Not a reflection of the present Financial Position

Firstly, financial statements do not show how well a company is performing in the present times. This is because they are made at the end of every financial year. Hence, they only depict performances of the previous twelve months. Even the value of assets and liabilities change as money’s purchasing power fluctuates.

2. Possibility of Bias

Financial statements might not always be an accurate representation of a company. This happens because they are based on several personal judgments, conventions and internal policies of accountants.

3. The Absence of Vital Information

Accountants might skip a lot of vital information while making financial statements. For example, the nature of agreements signed by the company is important information, but it is never mentioned in annual statements.

4. Lack of Qualitative Information

Although companies portray their numbers and finances in annual statements, a lot of qualitative data is skipped. Hence, details of the company’s industrial relations, employees’ productivity, etc. are generally missing from these statements.

5. Lack of Details

Financial statements might state the total value of assets, but they do not disclose the nature of these assets. Similarly, a lot of minute details like these do not find mention.

Solved Question for You

Question: Fill in the blanks in the following statements.

  1. The government uses financial statements to frame _____.
  2. _____ use annual statements to predict a company’s creditworthiness.
  3. The fact that accountants use personal judgment, convention, and internal policies to create financial statements shows that they suffer from _____.

Answers:

  1. policies
  2. Lenders
  3. bias
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