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Financial statements are the fundamental and official annual reports that business management uses to communicate financial information to its owners and external parties, such as investors, tax authorities, government, and employees. These include balance sheets at the end of the accounting period, the profit and loss statements, and the cash flow statements of a corporation. The main objective of financial statements is to provide information about the earning capacity of the business and cash flows.
Types of Financial Statements
The balance sheet, income statement, and cash flow statement are three types of financial statements businesses use to manage their operations and provide transparency to their stakeholders. All three statements are correlated and produce diverse aspects of a company’s operations and success.
Balance Sheet
A balance sheet is a statement that shows the financial worth regarding book value. The assets, liabilities, and shareholders’ investments of a firm are divided into three sections:
- Assets, such as cash and accounts receivable, reveal a lot about a company’s operational efficiency.
- Liabilities disclose the company’s expenditures and the debt capital that the company is repaying.
- Shareholder’s equity reflects information on equity investments and retained earnings from periodic net income.
Income Statement
The income statement compares a company’s revenue to its operating expenses to arrive at a bottom line or net profit or loss. At three different points, the report aids in analysing corporate efficiency.
- Evaluating gross profit starts with revenues and the direct costs linked with it.
- After that, it continues to operate profitably.
- The net income is calculated after deducting interest and taxes.
Cash Flow Statement
The cash flow statement shows how the company’s cash flows from operating, investment, and financing activities.
Objectives of Financial Statements
To provide information about economic resources and obligations of a business
- Financial statements have many objectives. These include offering information on the business’s resources, such as production capability, labour hours, liquid assets, stock, delivery method, and so on. It also delivers data on resource differences between two periods.
- This information helps better understand the business by allowing stakeholders to make financial decisions based on changes in acquiring resources and their utilisation.
To provide information about the earning capacity of the business
- The financial statements’ objective is to provide insight into the company’s earning power. This data is intended for the organisation’s highest executives.
- Management can decide on expansion levels based on economic assets and liabilities.
- Together, the three components of financial statements should convey information about the entity’s earning capacity.
- The use of available resources also has an impact on its earning potential.
To provide information about cash flows
- The cash flows of the company are also included in the financial statements.
- Creditors and investors can use this information to forecast the company’s liquidity and financial requirements.
Other objectives
- Communicating quantitative and objective information to their interested users helps make economic decisions.
- To cater to the unique requirements of conscientious creditors and investors.
- To serve as a financial foundation for tax assessments.
- To provide valuable data for foreseeing the company’s future earning capacity.
- To provide accurate information on the fluctuation of economic resources.
- To offer information on the organisation’s net resource changes.
- To offer accurate information on net economic resource changes.
- To offer information on the changes in the organisation’s net resources due to profit-oriented activities.
- Their objective is to make it easier to judge replacing fixed assets and expanding the business.
- They give the government the information it needs to make informed decisions about duties, taxes, and price control, among other things, as well as for legal and governance purposes.
- They devise corrective strategies to address discrepancies between actual and budgeted performance.
- They also give managers the required data and information for internal reporting and policymaking.
- They also serve to protect the interests of shareholders who are not permitted to participate in the company’s day-to-day operations.
- They assist credit rating agencies in determining the Company’s rating.
Conclusion
The financial statements’ magic provides information about an organisation’s operating results, economic status, and cash flows. Users of financial statements utilise the information to make judgments about resource allocation. Financial statements have the objective of providing information about a reporting entity’s financial activities and economic condition relevant to a wide variety of users for evaluating the entity’s management and making economic decisions. This goal is frequently achieved by concentrating solely on the information needs of current and potential investors, the defining user class. Present and future investors require information about the reporting entity’s financial activities and financial position that will help them assess the entity’s ability to create cash and its financial flexibility.
