Nature of Financial Statements

Financial statements provide financial information about a company’s financial status, such as revenues and expenses, which we acquire from the income statement. The balance sheet shows the assets and liabilities on a specific date. Without question, these sources of information are critical to the analyst’s capacity to evaluate a firm’s financial performance in terms of liquidity analysis, profitability analysis, management efficiency etc. Financial statements are made up of a combination of recorded facts, accounting conventions, postulates, and personal judgement.

Before we know the nature of financial statements, let us know the types of financial statements.

Types of Financial Statements

The balance sheet, income statement, and cash flow statement are used by businesses to manage their operations and provide transparency to their stakeholders. All three assertions are linked and produce diverse perspectives on a company’s operations and success.

•  Balance Sheet

A balance sheet is a statement that shows the financial worth of a corporation regarding book value. The assets, liabilities, and shareholders’ assets of a firm are divided into three sections. Short-term assets, such as cash and accounts receivable, reveal a lot about a company’s operational efficiency. Liabilities reveal the company’s expense arrangements and the debt capital it is repaying. Shareholder’s equity reveals 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 separate points, the statement aids in the analysis of corporate efficiency. Evaluating gross profit starts with revenues and the direct costs linked with it. After that, it continues to operate profit, which subtracts indirect expenditures like marketing, general, and depreciation. 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 are distributed. The top-line item for operating operations is net income, which is carried over to the cash flow statement.

Nature of Financial Statements

• Recorded Facts

Only financial transactions, which are stated and measured in terms of money or money’s worth, are documented chronologically in accounting. As a result, such recorded data can be found in financial accounts created from data contained in financial transactions.

These data are referred to as historical documents/evidence because they are the consequence of previous operations. Financial statements are generated and delivered to accounting information consumers based on such documents.

• Accounting Conventions

Convention refers to a broad agreement on social or economic usage and practices. In other words, it is a long-established accounting technique followed by the accounting community.

The following are examples of accounting conventions

• Convention of Disclosure

 According to the disclosure doctrine, all financial statements should be honest, and complete disclosure of all significant facts must be given. It entails properly classifying, summarising, aggregating, and explaining accounting data in unpublished financial statements that are of material relevance to users such as proprietors, investors, and others.

• Convention of Materiality

 ‘Relative importance’ is what materiality signifies. In other words, whether or not a topic should be revealed in financial statements is determined by its materiality or if it is significant.

• Convention of Conservatism

 Conservatism refers to traditional values and traditions, as well as a reluctance to depart from such established principles and practices and a desire to play it safe. In a nutshell, it is a precautionary policy or a practice of playing it safe that evolved as a buffer against possible losses in an unpredictable world.

• Conservation of Consistency

 This doctrine states that accounting rules, practices, and conventions should be followed and applied regularly. To put it another way, these should not alter from year to year or from one year to the next. When accounting standards, methods, and practices are consistently followed from year to year, comparisons of results between years are meaningful and important.

•  Postulates

A self-evident or axiomatic principle is assumed to be true. In other terms, it is an assumption or postulate that is believed to constitute the foundation of a system of thought or an established field of endeavour. Its legitimacy has been acknowledged.

In simple terms, a postulate is (i) an axiom and (ii) an assumption that has already been proven correct. It is seen to be a more fundamental and universally acceptable character that may be used in any situation. Due to its wider universal application, the same will be true and workable in a wide range of scenarios.

Fundamental postulates attempt to create rules and processes for a system with many different dimensions as well as to explain and maintain the existing system.

Conclusion

Financial statements are often prepared to reflect the financial situation of a business concern at a specific point in time as well as operating performance for the period under consideration. The financial statement’s interested parties believe that the values as seen in the financial statements are true and absolute. However, this is not an accurate interpretation. The figures in financial statements are never representative of current or economic values. The facts listed above, such as accounting conventions and postulates, significantly impact the data reported in financial statements.