In the preparation of final accounts of a firm, the financial statements display the net results for the given year. They play a vital role in allowing a user of a financial statement, to understand the results of a firm for a given year. Let us find out more about what a financial statement is and their relevance.
The Components of a Financial Statement
Broadly, the following make up a part of the financial statements of any firm or organization:
- Balance sheet: It shows a statement of financial position, the entity’s assets, liabilities, and stockholders’ equity as on the report date. However, it does not show information that covers a span of time as it shows figures of assets and liabilities on a particular date.
- Income statement: It shows a statement of comprehensive income, statement of revenue and expenses and p/l report. It includes items of revenues, expenses, gains, and losses. It also provides information on operations carried out by the enterprise.
- Cash flow statement: It helps in showing the changes in the entity’s cash flows including operating, investing and financing activities during the reporting period.
- Explanatory notes: These include explanations of various activities, additional detail on some accounts, and other items.
What is the use of a financial statement?
As a whole, financial statements fulfil the following purpose, which makes them indispensable:
- First, to scrutinize the ability of a business to generate cash and the sources and utilization of that cash.
- Second, to ascertain whether a business has the capability to pay back its debts.
- Third, to help track financial results on a trend line to spot any looming profitability issues.
- Next, to help derive financial ratios from the statements that can indicate the condition of the business.
- Lastly, to investigate the particulars of certain business transactions, as mentioned in the disclosures that accompany along with the statements.
If a business has plans to issue its financial statements to outside users such as investors or creditors, the financial statements should be ideally formatted in accordance with one of the major accounting frameworks. These frameworks allow for some leeway in how financial statements can be structured, so statements issued by different firms even in the same industry are likely to have somewhat different appearances. Financial statements that are being issued to outside parties may be audited to verify their accuracy.
Browse more Topics under Financial Statements
- Distinction between Capital Revenue and Capital Expenditure
- Operating Profit
- Trading and Profit and Loss Account
- Balance Sheet and Opening Entry
- Stakeholders and their Information Requirement
- Depreciation, Bad Debts and Provision for Bad and Doubtful Debts
- Need for Adjustment, Closing Stock and Outstanding Expenses
- Prepaid Expenses, Accrued Income and Income Received in Advanced
- Provision for Discount on Debtors, Managers Commission and Interest on Capital
- Manufacturing Account
Question for You
Ques: Give examples of some users of financial statements.
Answer –Following are some of the external users of financial statements:
- Creditors: They wish to know the recoverability of their dues.
- Government: the authorities pay heed to the figures of revenue in a financial statement so that they can calculate the taxes correctly.
- Management: They wish to assess how well their decisions have transformed into useful outputs and how far have they been able to achieve the targeted results.
- Employees: they wish to create a demand for an extra bonus, based on the revenue earned by a firm and judge the reasonableness of their pay.