Financial statements report on a company's income, cash flow and equity.
Define the purpose of a financial statement
The residual claim or interest to investors in assets after all liabilities are paid. If liability exceeds assets, negative equity exists and can be purchased through stock.
an obligation of an entity arising from past transactions or events, including any type of borrowing
economic resources that represent value of ownership that can be converted into cash (although cash itself is also considered an asset)
A financial statement is a formal report of the financial activities of a business, person, or other entity. Financial statements are a key component of accounting; the process of communicating information about a financial entity . Financial statements are presented in a structured manner with conventions accepted by accounting and regulatory personnel. An entity's financial statement typically includes four basic components: a balance sheet, income statement, cash flow statement, and statement of changes in equity:
Financial Statements help keep money organized.
For complex entities, financial statements often include an extensive set of notes as an explanation of financial policies. The notes typically describe each item in detail. For example, the notes may explain financial figures or the accounting methods used to prepare the statement.
Uses of the Financial Statement
Financial statements are used to understand key facts about the performance and disposition of a business and may influence decisions.
Explain how financial statements are used by different entities
Financial analysis (also referred to as financial statement analysis) refers to an assessment of the viability, stability, and profitability of an organization or project.
Financial Statements are used for a Multitude of Different Purposes. Readers of a financial statement are seeking to understand key facts about the performance and disposition of a business. They make decisions about the business based on their reading of the statements. Because financial statements are widely relied upon, they must be straightforward to read and understand.
For large corporations, these statements are often complex and may include an extensive set of notes to the financial statements and explanation of financial policies and management discussion and analysis. The notes typically describe each item on the balance sheet, income statement, and cash flow statement in further detail. Notes to financial statements are considered an integral part of the financial statements.
Owners and managers frequently use financial statements to make important business decisions, for example:
The documents are also helpful in making long-term decisions and as a source of historical records .
One of the uses of financial statements is as a budgeting tool, as in this example.
Other individuals and entities use financial statements too. For example:
Financial statements can be limited by intentional manipulation, differences in accounting methods, and a sole focus on economic measures.
Summarize the common limitations found in financial statements
involves the roles and relationships between a company's management, its board, its shareholders and other stakeholders, and the goals for which the corporation is governed. Much of the contemporary interest in corporate governance is concerned with mitigation of the conflicts of interests and the nature and extent of accountability of people in the business.
an audit of financial statements is the verification of the financial statements of a legal entity intended to enhance the degree of confidence of intended users in the financial statements by providing reasonable assurance that the financial statements are presented fairly.
Generally Accepted Accounting Principles refer to the standard framework of guidelines, conventions, and rules accountants are expected to follow in recording, summarizing, and preparing financial statements in any given jurisdiction.
The limitations of financial statements include inaccuracies due to intentional manipulation of figures; cross-time or cross-company comparison difficulties if statements are prepared with different accounting methods; and an incomplete record of a firm's economic prospects, some argue, due to a sole focus on financial measures .
Consolidated financial statements
Financial statements can include a number of inaccuracies and limitations that affect the way a company can be viewed.
One limitation of financial statements is that they are open to human interpretation and error, in some cases even intentional manipulation of figures. In the United States, especially in the post-Enron era, there has been substantial concern about the accuracy of financial statements. High-profile cases in which management manipulated figures in financial statements to indicate inflated economic performance highlighted the need to review the effectiveness of accounting standards, auditing regulations, and corporate governance principles.
As a result, there has been renewed focus on the objectivity and independence of auditing firms. An audit of the financial statements of a public company is usually required for investment, financing, and tax purposes, and these are usually performed by independent accountants or auditing firms and included in the annual report. Additionally, in terms of corporate governance, managing officials like the CEO and CFO are personally liable for attesting that financial statements are not untrue or misleading, and making or certifying misleading financial statements exposes the people involved to substantial civil and criminal liability.
Another set of limitations of financial statements arises from different ways of accounting for activities across time periods and across companies. This can make it difficult to compare a company's finances across time or to compare finances across companies. Different countries have developed their own accounting principles, making international comparisons of companies difficult. However, the Generally Accepted Accounting Principles (GAAP), a set of guidelines and rules, are one means by which uniformity and comparability between financial statements is improved. Recently there has been a push toward standardizing accounting rules made by the International Accounting Standards Board (IASB).
Another limit to financial statements as a window into the creditworthiness or investment attractiveness of an entity is that financial statements focus solely on financial measures of health. Even traditional investment analysis incorporates information outside of the financial statements to make organizational assessments. However, other methods such as full cost accounting (FCA) or true cost accounting (TCA) argue that an organization's health cannot just be determined by its economic characteristics. Therefore, one needs to collect and present information about environmental, social, and economic costs and benefits (collectively known as the "triple bottom line") to make an accurate evaluation.