What are the financial statements?
How to obtain financial statements?
What information financial statements provide?
How and why financial statements are useful?
Who prepares financial statements and how often?
Why do investors want to have a look at the financials?
If any of these questions keep you anxious and restless, then, I am sure you’ll find comforting answers here, plus you’ll learn a lot additional.
Accounting & finance professional often use the word of financial statements in their life. Similarly, investors, bankers and auditors use this term frequently as well. This term is also used as a short ‘financials’ only, like “where are the financials of 2010” etc. Here the word ‘financials’ refer to ‘financial statements’. If you are new to this field or want to know more details about the type of financial statements and what are their contents, you have come at the right spot.
The term ‘financial statements’ refers to a set of documents or reports which provide financial information about a business or a person. These financial statements are prepared to provide information about the financial situation of the company to external parties. Therefore, sometimes, these are also referred to as ‘external financial statements’ but usually referred to as ‘financial statements’ only (or sometimes as ‘financials’ only).
Financial statements serve below purposes for different readers:
For Shareholders: Shareholders are considered to be primary users of financial statements, they are the owners of the company, and they need to know how is their business performing. So, shareholders use these financial statements to make suitable business decisions or investment decisions.
Financial statement provide information about profitability, financial strength and liquidity of the company, and potential investors can utilize financials to perform analysis and make suitable investment decisions.
Regulators and tax authorities:
Regulators and tax authorities utilize these financial statements to regulate industries and cross-check tax calculations
Competitors and Industry analysts:
Competitors and industry analysts use financial statements to understand the strategy and performance of the company.
Listed companies and other regulated companies are required to publish their audited financial statements. This the financial information of such companies become public and different stakeholders can obtain these financial statements. However, for private companies, usually the financial statements are not disclosed publicly, and only authorized parties get access to it. These authorized parties may include shareholders, bankers, tax authorities and, of course, auditors.
Financial statements usually contain the following documents (or reports):
- Statement of Financial Position (or Balance Sheet)
- Income Statement (or Profit and Loss Account)
- Statement of Cash Flows (or Cash Flow Statement)
- Statement of Changes in Equity
Statement of Financial Position (or Balance Sheet)
A balance sheet is one of the primary financial statements. This document is typically the first one in the set of financial statements. The term balance sheet is used for this document as this statement contains two sides: one is the assets side, and the other is liabilities and equity side. Both sides of the balance sheet should be equal in value and thus, balanced. Therefore, we use the term balance sheet as both sides of this statement are equal in value. All debits and credits are matching in total amounts. If a balance sheet is out of balance, then it means that it is not a balance sheet J.
This statement is also referred to as a statement of financial position as it displays information about the financial situation of the company; it provides information about the financial strength (or weakness of the company). It states how much assets a company owns and how many liabilities it owes. A balance sheet is a beautiful snapshot and an excellent presentation of the company’s assets, liabilities and equity on a single page. (Usually on a single page, though you may expect two pages also).
We can use a company’s balance sheet for calculation of various key and important ratios like current ratio, quick ratio, debt-equity ratio etc. We can use these ratios for multiple financial analysis purposes.
It is pivotal to understand that the balance sheet is a company’s snapshot of its financial strengths (or weaknesses) at a given date only. This one day’s view means that balance sheet provides the situation as of on a particular date, it is not for a specific period etc. Let’s understand that if a balance sheet is prepared as on 31 December 2010, then all the items on balance sheet would provide details of assets, liabilities and equity which are existing as on 31 December 2010. It would not include any elements which have ceased to exist on or before 31 December 2010. It will also not add any item acquired after this date.
For example, if a building is purchased by the company on 25 December 2010, then this building will appear on the balance sheet of the company as on 31 December 2010. However, if the same building were purchased on 5 January 2011, then this building would not appear on the balance sheet of the company dated 31 December 2010.
It is also good to realize that balance sheet numbers are ‘cumulative’ numbers, i.e., these balances are closing figures as at balance sheet date of all the transactions which happened from the inception of the business till the balance sheet date.
If you are planning to invest in a company (whether in it’s bonds or shares) then a balance sheet is an essential source of information which can provide critical information which will help take a right decision. For example, whether the company is highly geared or not, how many liabilities it already owe, what are it’s highest assets and how much cash the company already has, all these information are available from the balance sheet (or statement of financial position) of the company.
Income Statement is one of the essential items in the financial statements. It provides a significant source of information when a company needs to explain it’s financial performance or when a competitor needs to know the sales of a company. The income statement is also essential when an investor wants to know how much is the profit for the company or when a shareholder wants to know EPS (earning per share). Similarly, when a lender wants to see the finance cost of the company, he can utilize the income statement.
The income statement is also referred to as ‘profit and loss account’ (not ‘profit or loss account’, please). The correct term is ‘profit and loss account’ (and not ‘profit or loss account’). The general structure is that the statement usually starts with the revenue figure, then deducts the cost of sales. After that, there are general and admin expenses, sales and marketing expenses and other expenses. The outcome after deduction of taxes and interest is net profit (also referred to as net profit after tax).
The income statement is also referred to as ‘statement of comprehensive income’ if it includes ‘other comprehensive income’. (As per revised IAS 1)
The income statement is usually prepared for a period, i.e., let’s say for one year. So, if the income statement is prepared for the year ended 31 December 2010, this means that the income statement is a summary of all income and expenses related transactions which happened for the period from 1 January 2010 to 31 December 2010. This periodicity is in contrast to a balance sheet which is representative of one particular day’s reflection of assets, liabilities and equity of the company, while income statement is representative of all the transactions which happened in that period (a year or quarter etc.)
Statement of Cash Flows (or cash flow statement)
The title of ‘cash flow statement’ was changed to ‘Statement of Cash Flows’ in 2007 under the amendments to IAS 1. As both names depict, the statement describes the movement of cash for a business for a given period. This statement is a useful tool to understand how much money (cash) is generated or consumed by different activities of the company. These business activities are broadly classified as ‘operating’ activities, ‘investing’ activities and ‘financing’ activities.
The statement of cash flows is usually presented at the third spot (after balance sheet and income statement) in the financial statements. The usability of this report is quite limited as compared to the first two statements.
Statement of Changes in Equity
This report is the fourth and last statement in the set of financial statements. After this, there are usually notes, disclosures and break-ups of different items of financial statements. Statement of Changes in Equity (SOCE) is a shareholder specific statement. It would provide information on whether there has been any change in the equity, i.e., any movement in the shareholders’ equity.
E.g., a dividend is reflected in SOCE as an addition in the dividend reserve and a decrease in retained earnings. Similarly, if new shares are issued, they will be revealed as an addition to the shareholders’ equity of the company. SOCE is especially for shareholders and provides essential information about the movement in the equity, although this statement may not be of great interest to other readers of financial statements.
General Points related to Financial Statements
Usually, a company’s financial statements are prepared by its accounts team. Depending upon the structure of the department, it is often accounts manager or financial reporting manager who is responsible for the preparation of the financial statements.
Financial statements are usually prepared for the current date (or period) as well as a comparative date (or period). For example, if a company is producing a balance sheet as at 31 December 2010, it’ll also provide figures for last year, i.e., balance sheet as at 31 December 2009. These comparative figures are provided because a comparison of the numbers can be made between two years. Thus a reader of the financial statements will be able to
In large complex organizations, it is usually the CFO who is ultimately responsible for ensuring correct preparation and presentation of financial statements. Although multiple managers and specialists support him.
In small companies, either the financial statements are prepared by the company’s accounts staff itself, or sometimes the external auditors will also provide this service to compile financial reports on behalf of the company. The preparation of financial statements is a service provided in addition to the audit of the financial statements.
As a person having an interest in accounting & finance, I would invite you to download the financial statements of multiple companies and go through their annual reports. These yearly reports would contain financial statements of the company along with other information. Many companies (usually public and listed companies) provide their financial accounts on their websites free of cost, either as a regulatory requirement or to attract more investments from shareholders). A review of these set of financial statements would significantly enhance your knowledge and quench your thirst for reviewing financial statements.
As a reader possessing an interest in accounting & finance, I would invite you to download financial statements of multiple companies and go through their annual reports. These yearly reports would contain financial statements of the company along with other information. Many companies (particularly public and listed companies) provide their financial statements on their websites free of cost, either as a regulatory requirement or to attract more investments from shareholders). A review of these set of financial statements would significantly enhance your knowledge and quench your thirst for reviewing financial statements.
Another important concept when discussing financial statements is that whatever we read above is related to external financial statements. However, companies prepare their internal financial statements also which are referred to as ‘management accounts’. The components of management accounts are usually same i.e., income statement, balance sheet and cash flow statement etc. However, there might be some additional statements like daily cash position, flash report or product-wise profitability report etc.
These management accounts are prepared for the use of management to make the right business decisions. These management accounts are not shared with anyone outside the organization. This area of accounting is governed more by cost accounting or management accounting, while the external financial statements are dealt more under financial accounting. Our article titled Management Reporting would provide you detailed knowledge on this topic.