Meaning & Uses of Financial Statements
The financial statements of a company reveal the exact position of its financial performances. These statements are prepared at the end of all accounting process for a particular period. The internal users of financial statements are owners, managers, and employees. The external users of financial statements are banks, financial institutions, potential investors, tax authorities, suppliers, etc.
Financial statements contain the following reports:
Profit & Loss A/c
Income Sheet
Balance Sheet
Use of Financial Statements
They play a major part in making financial decisions of a business. The main uses of financial statements are as follows:
Assisting the Management
The financial statements exactly reflect the financial position of a company and thus bridge the gap between the management and the owners. Since the shareholders and the public can view the statements they can also watch the performance of the business.
Availing Loans
Financial statements play a major role in availing loans or borrowing funds for better functioning. The lenders may be banks and various other financial institutions.
Assessing the Finances
The financial statements are used to assess the company’s business, thereby figuring out the term of the company’s solvency.
For the Government
The policies laid out by the government are based heavily on financial statements. They use a company’s financial statement to decide on taxation and other regulatory policies.
For the Stock Exchanges
The financial statements are very much useful for regulatory bodies like various stock exchanges for so many reasons. They can assess a company’s internal matters using those statements whilst ensuring the protection of investors.
Information on Investments
Mainly, the shareholders of a company depend on these statements only to know about their investments. This allows them to make more investments in case of profit, whereas to pull out in case of loss.
Limitations of Financial Statements
Investors should be well aware of the factors that they depend on to invest in or pull off from the business.
The following are the limitations of financial statements
Dependence on historical costs
Inflationary effects
Intangible assets not recorded
Based on a specific time period
Not always comparable across companies
Subject to fraud
No discussion of non-financial issues
Not verified
No predictive value
After the limitations of financial statements, let’s now take a look at the P&L statement.
Profit & Loss Statement
This is one of the financial statements that are generated quarterly or annually. This statement summarizes the income gained and the expenses incurred for a particular period. The following is an example of a profit and loss statement.
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One of the examples of Profit and Loss account is given below:
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Uses of Trial Balance
A trial balance is a type of report which is prepared at the end of a financial period. This is generated before preparing the financial statements. The main purpose of preparing a trial balance is to find out accounting errors if any. Further to which needed adjustments are done to make prepare accurate financial statements.
The limitations of trial balance are:
No proof of recorded transactions
No proof of correct ledger entries
Numerous errors may be found even though the columns are balanced
Can miss out journal entries
Cannot find ledger entries
Cannot protect the repeated entries
Cannot protect the offsetting errors
Cannot protect the errors of principles
Cannot protect the errors of commission
Cannot protect the errors of omission
Uses of Balance Sheet
To determine if working capital is enough
To know the business net worth
To see if the company can sustain the future operation
To identify if there’s possible issuance of dividend
Limitations of Balance Sheet
The limitations to balance sheets are assets may be recorded at historical cost, using of estimates, and the omission of valuable assets.
Uses of Financial Statement Analysis
Financial statement analysis is used by all stakeholders whether internal or external, to figure out the performance of a business and value the same. All business entities create a balance sheet, income statement, and cash flow statement that are very important for financial statement analysis. It helps the government agencies to analyze the taxes owed to the firm.
Certain limitations of financial analysis are depreciation, the cost basis that excluded inflation, different accounting methods, unusual data, useful information, and a company's diversification.
FAQs on Financial Statements of a Company
1. What are the uses of Funds Flow Statement?
Ans. This is a financial document that analyses a company’s two years Balance Sheet of two years to evaluate the fund flow between the years of funds from the previous financial year to the current year. We can also say that it compares the source of inflow and outflow of funds during the particular accounting period and analyses how it affects the working capital of a business. It is a key element to determine the fund’s movement in business. Thus the business analyst can assess the fund’s required for the organization in the near future. It is also referred to as Application of the Funds and Statement of Sources. It serves as important criteria to control finance and plan well to utilize funds.
2. What are the limitations of Financial Ratios?
Ans. Financial ratios play a major role in the preparation of financial statements analyses report and accounting research of business. However, they have some limitations. There are various limitations in financial ratios. And, understanding them thoroughly results in drawing concrete conclusions for a business. Since the ratio consists of a numerator and a denominator, it could result in a misstatement of either of them. The financial ratios are determined using the company’s principles, accounting classifications and methods framed by them. But they may not be consistent over a period and results in compromising and comparability. Finally, the limitations must be marked before coming to any financial conclusions.