Concept of Financial Statements
Financial statement is written reports of financial affairs of a company which reports and communicate the result of its business operations for a particular period of time and its financial position at the end of that period. The results of the business operation are revealed by the net profit it has earned during the period. The financial position of the company is determined by presenting the picture of its assets, liabilities and shareholders equity at the end of the period. Generally, therefore, the financial statements of the company include its trading and profit and loss account known as the income statement and balance sheet.
Moreover, the company is required to prepare and publish cash flow statements at the end of the period, besides profit and loss account, profit and loss appropriation account and the balance sheet.
“Nepal Accounting, Standard, July 2002” emphasizes the preparation of financial statements by the company and offers a framework for the preparation and presentation of these statements. Accordingly, the financial statement of the company contain the following:
- Income statement or trading and profit and loss account for showing the results of its business operations in terms of net profit earned or net loss suffered during the period of reporting.
- Statement of retained earnings or profit and loss appropriation account for showing the change in the profit position of the company during the reporting period. The change in a profit of the company occurs due to the appropriation of profits into dividends, reserves and fund and taxes.
- The balance sheet for showing the financial position of the company as the end of the period. The financial position of the company can have revealed through the picture of its assets, liabilities and shareholders equity.
- Statement of changes in financial position or cash flow statement for showing the changes in the company’s cash position during the period. The changes in the cash position of the company resulting on account of cash inflows and outflows occurring from its operating investing and financial activities.
Objectives of financial statements
Financial statement is the means of communicating financial information to the users of such information. It is equally important to the management, shareholders, creditors, suppliers, employees, customers, tax authorities, financial researchers, etc. The following are the main objectives of financial statement:
- To provide the financial information to the users.
- To provide users financial information for predicting, comparing and evaluating potential cash flow of the business.
- To help the users to know regarding earning power of the business.
- To provide information to judge management’s ability to utilize resources effectively.
- To provide a statement of financial position concerning assets and liabilities of the business.
- To provide the financial statements on a periodic basis to make the comparison of the progress of the business.
- To provide useful financial information for financial forecasting.
Importance of Financial Statements
Financial statements provide valuable financial information to various users for different purposes. The importance of financial statements can be pointed out as follows:
- It provides the information relating to existing profit, earning per share, the possibility of growth cost information and other necessary financial information.
- It provides the information relating to the changes of business promotion and capacity of the business.
- It provides the information to the employees relating to changes increments of salary, bonus, job security, employee’s welfare scheme, etc.
- It provides the information to the creditors and bankers and other financial institutions to know the capability to repay the amount and interest as and when repayment becomes due.
- It provides the information to the government to known the amount of tax on the revenues.
- It provides the information to the customers about new product research, social responsibility and other policies of the business.
- It provides the information to the potential investors to know the earning potential of the business.
Limitations of Financial Statements
The following are the main limitations of financial statements:
- It provides the information relating to only monetary facts.
- It records the financial information relating to historical in nature.
- It is an only interim repost.
- It is influenced by accounting concept.
- It fails to disclose the adequate information.
- It ignores the effects of price level changes.
- It is prepared primarily for shareholders.
Financial Statement Analysis
The figures of the company’s financial statements particularly the profit and loss account and the balance sheet do not communicate the user much unless they are properly analyzed and interpreted. The company’s profit and loss account show only the absolute figures of revenues, expense and profit or loss occurred during a particular period. It does not, however, reveal whether the company’s revenues and expenses have increased over the year or its net profit has been company’s balance sheet also does not reveal more than what is the position of its assets, liabilities and shareholders’ equity at a certain point of time. Therefore, it is essential to analyze the figures of financial statements so that important financial information can be obtained thereof.
The analysis of financial figures contained in the company’s profit and loss account and balance sheet by employing appropriate techniques is known as financial statements analysis. Formally, financial statement analysis is defined as the process of analyzing and interpreting the financial figures contained in the statement by developing some relationships among the figure in such a manner that meaningful information can be obtained about the liquidity, efficiency, profitability and leverage position of the company.
Thus, the analysis of financial data in a purposeful manner whereby a user can easily classify and group the financing data in a purposeful manner andncan easily understand about the survival, stability, profitability and growth prospect of the company. The analysis of financial statements includes the following activities:
- Arranging and classifying financial data in a purposeful manner.
- Judging the interrelationship of financial figures in a meaningful manner.
- Obtaining information in a conclusive manner for the purpose of decision-making.
Objectives of Financial Statement Analysis
The following are the important objectives if financial statements analysis:
- To know about profitability: The financial statement analysis provides information about the profitability of the company in terms if sale and investment. The profitability scenario helps shareholders to decide whether to continue holding its shares and other potential investors to decide whether to invest in its share or not.
- To judge solvency: An analysis of financial statements is helpful for judging the short-term and long-term solvency of the company. The banks with such information will be in a position to decide whether it should extend the loan or not.
- To measure strengths and weaknesses: The analysis of financial statements helps to measure the financial strengths and weakness of the company which is essential for deciding its future course of action.
- To assets managerial performance: The financial statement analysis is essential for measuring the company’s managerial performance, which is important to decide about rewarding the management or taking action against it.
- To make future planning: The financial statement analysis provides relative information guidelines for making future plans of the company by deciding what course if action should it takes to achieve its objectives.
Note: The objectives of the analysis of financial statement are to provide financial information to the investors, creditors, management and other interested groups about the company’s profitability, solvency, strengths and weaknesses, managerial performance for future plans.
Koirala, Madhav et.al., Principles of Accounting -XII, Buddha Prakashan, Kathmandu
Shrestha, Dasharatha et.al., Accountancy -XII, M.K. Prakashan, Kathmandu
Bajracharya, Puskar, Principle of Accounting-XII, Asia Publication Pvt. Ltd., Kathmandu