Records of various business activities are maintained to ascertain financial position and profit earning capacity of a business concern. Statements prepared from the accounting records of an organization are called financial statements.
That is, the statements that are prepared at the end of a particular accounting period to measure the overall result of business activities and exhibit the financial position of a business concern are generally called financial statements.
In modem business world two statements are generally termed as financial statements.
These two statements are –
(a) Income statement and
(b) Balance sheet.
Besides, some other statements are also included in financial statements.
These statements are also very much important for many reasons, particularly in taking financial decisions. Of these statements, statement of retained earnings, cash flow statements and fund flow statement are mentionable.
The net income or net loss of a business concern for a particular accounting period can be known from the income statement.
The summary of financial position of a business concern reflected by the records relating to accounts at the end day of accounting period can be known through balance sheet. This statement also shows how net income is distributed into different heads.
Changes in working capital of a particular period can be known from fund flow statement. This statement provides necessary information regarding sources of working capital and their uses. Cash flow statement provides the sources of cash receipt and payments under different heads for a particular period.
Financial statements represent a brief picture of financial activities of a company.
Regarding financial statement Donald E. Kieso, Jerry J. Weygandt and Terry D. Warfield have stated in their Intermediate Accounting (10th edition) : “Financial statements are the principal means through which financial information is communicated to those outside an enterprise. These statements provide the firm’s history quantified in money terms.
The financial statements most frequently provided are
(l) the balance sheet,
(2) the income statement,
(3) the statement of cash flow, and
(4) the statement of owner’s or stockholder’s equity. In addition, note disclosures are an integral part of each financial statement.”
The American Institute of Certified Public Accounts states that, financial statements are integrated information of recorded events, accounting conventions and individual judgment capacity.
Judgment capacity that is used, influence the statement materially.
Presentation of financial data including Balance Sheet, Income Statement, and statement of cash flow or any supporting statement that is intended to communicate an entity’s financial position at a point in time and its results of operations for a period then ended.
Components of Financial Statements
Financial statements are mainly four statements and generally prepared by most of the business concerns. These are;
- Income statement
- Owner’s equity statement
- Balance sheet.
- Statement of cash flow. These for are the most important other statements are;
- Retained earnings statement.
- Statement of fund flow
- Notes to accounts and disclosure.
The statement which is prepared at the end of a particular accounting period with the help of periodic income and expenditure to know the operating result i.e. profit or loss of a company is called income statement.
The main source of income of a business concern is sales and for profiteering service oriented organization is the income received from service rendered.
Besides these, other incomes are interest received on investment, profit or sale of assets etc.
Expenditures mean merchandise purchase of a particular period and operating expenses of a particular period such as administrative expenses, selling and distribution expenses and other expenses.
Owner’s equity statement
The statement which is prepared showing changes of owner’s equity for a particular period is called owner’s equity statement.
In this statement profit of a particular period is added with the beginning capital of that period and loss if any, drawings are deducted for ascertaining ending capital of that particular period.
A balance sheet is prepared at a particular date to know the financial position of a company of that particular date. The ledger account balances that remain after preparation of income statement are assets, liabilities and capital.
The statement which is prepared on the end day of an accounting period with assets, liabilities and owner’s equity is called balance sheet. Balance sheet is called the statement of financial position.
Cash flow statement
In the present day, cash flow statement is considered as an important part of financial statements. In corporate business organizations, preparation of cash flow statement is mandatory.
The statement, which is prepared to show cash inflow and cash outflow for a particular period, is called cash flow statement.
Importance of Financial Statements
Accounting is an information communication system. Through financial statements necessary information is communicated to various interested parties. Financial statements play a role in providing information.
Financial statements are considered as the mirror of a business concern because they reflect the working capacity or weakness of a business concern. Financial statements come to the use of various parties.
For example, management, investors, banks, creditors, officials, government, business organizations, consumers and general mass are benefited by financial statements. George May has classified the financial statements from which parties are benefited into ten;
- Reports of financial supervisor,
- Basis of revenue principles,
- Dividend determining principles,
- Dividend payment basis,
- Basis of granting loan,
- Information to potential investors,
- Investment value determining,
- Government supervisory control,
- Basis of cost control,
- Basis of tax principles.
Discussion of importance of financial statements to various parties
The owner or management can know the results and true financial position of a business from financial statements. With the help of the statements it becomes easier to take decision regarding expansion or contraction of business as per necessity.
For example, if ratio of return of investment is comparatively high, the management is inspired to invest more. On the other hand if the business incurs loss, management may take decision to contract the business or to close it down.
That is, management can take proper and timely decision determining success or failure of a business with the help of financial statements. Total assets of business, total outstanding credits and debts are available in financial statements.
Investment is of both long term and short term. A conscious investor invests in a business after proper consideration of its debts, assets, profit earning capacity etc. The investor takes into consideration the paying capacity of interest and the security of his investment.
Investor can analyze long, term financial capacity of a concern from financial statements. Besides current analysis and interpretation, the investor analyses the future financial position with the help of financial statements.
A business is to repay the creditors within short-term. This debt is paid out of current assets. Therefore, the creditors are interested to know the position of current assets.
Financial solvency of a business concern can be ascertained with the help of current ratio and acid test ratio prepared with current assets and current liabilities mentioned in the balance sheet.
Bank always considers security of the loan given to the business concern. It also studies financial capacity of the business concern regarding regular payment of interest on loan.
Bank interprets balance sheet of a business concern to know financial solvency and debt paying capacity of a business. It also studies the revenue earning capacity of the business.
Financial statements are important to the government for various purposes. The government can be aware of income tax, VAT, sale tax, duties etc. payable to government by business concerns from financial statements.
Besides, in formulating trade policy, taxation rules, industrial policy etc. of a country financial statements of business concerns play an important role.
Government analyses the financial position of the country from financial statements of business concerns. These financial statements are the proofs of compliance with the government rules in running the business.
Trade associations render necessary services to their members to protect interest. They can fix up the benefits to be provided to their members by interpreting and analyzing financial statements of the business concern.
Employees’ interests are directly related to financial progress and regress of the business concern. Employees always remain eager to know the true financial position of a business concern and this can be known from financial statements.
Shares and debentures of various companies are traded through stock exchange. Financial statements help the share brokers know financial position of a business concern. Values of securities of a business concern are fixed up on the basis of its financial statements.
The consumers remain interested regarding controlled accounting system which minimizes cost of production resulting in availability of goods at a cheaper price.
Financial statements are important to research scholars engaged in financial research work of a country. Because, they can have necessary data from financial statements of business concerns.
Mass people are also benefited from the financial statements of business concerns. Flourishment of business leads a country to the path of development by increasing investment.
As a result employment opportunities increase, regular supply of good at reasonable rates is ensured. This helps social development increase standard of living of the mass people.
From the above discussion it can be said that, the financial statements of a concern mean consolidated position of some matters.
a statement of asset and liabilities prepared at the end day of the year, an income statement determining results of business activities of a particular period, cash flow and fund flow statements showing the reasons of changes of cash and funds, statement of owner’s or stockholder’s equity and notes to accounts and disclosure.