Definition of Financial Statements
Financial statements are the set of written records that reflect the financial results and performance of the business activities carried out by an entity during the reporting period. They reflect the result of the accounting transactions and events carried out in any entity. The set of financial statements contain five components namely the Balance Sheet, Income Statement, Cash Flow Statement, Notes to Financial Statements, and Statement of Changes in Equity.
Explanation
All the transactions that are conducted by an entity are recorded on a daily basis by way of accounting entries. At the end of the reporting period, the result of all the transactions and entries is compiled in the form of financial statements. They reflect the position of profits or losses, assets, liabilities, and equity. Financial statements reflect the financial position, strength, and liquidity of the entity during a particular reporting period.
Example of Financial Statements
Here is a draft format for the Balance Sheet as per IFRS (International Financial Reporting Standards).
Balance Sheet as At
| Particulars | Notes | Year ended 20XX | Year ended 20XX |
| Non Current Assets | |||
| Property, plant and equipment and Investment Property | |||
| Goodwill | |||
| Advances for Capital Assets | |||
| Intangible assets | |||
| Investments | |||
| Investments in associates | |||
| Available for sale investments | |||
| Receivables and other non-current Assets | |||
| Deferred tax assets | |||
| Total Non-Current Assets | – | – | |
| Current Assets | |||
| Inventories | |||
| Trade receivables | |||
| Other current assets | |||
| Income tax assets | |||
| Investments and financial receivables | |||
| Cash and cash equivalents | |||
| Total Current Assets | – | – | |
| Total Assets | – | – | |
| Shareholders’ Equity | |||
| Share capital | |||
| Reserves | |||
| Retained earnings | |||
| Total Shareholders’ Equity | – | – | |
| Non-Current Liabilities | |||
| Interest-bearing loans and short term borrowings | |||
| Employee benefits liabilities | |||
| Provisions | |||
| Deferred tax liabilities | |||
| Total Non-Current Liabilities | – | – | |
| Current Liabilities | |||
| Banks overdrafts and short-term borrowings | |||
| Interest-bearing loans and short term borrowings | |||
| Trade payables | |||
| Provisions | |||
| Income tax liabilities | |||
| Other liabilities | |||
| Total Current Liabilities | – | – | |
| Total Liabilities | – | – | |
| Total Shareholders’ Equity and Liabilities | – | – |
Source: https://www.caclubindia.com/share_files/files_download.asp?cat_id=1&files_id=21900
Types of Financial Statements
There are five types of financial statements that are generally prepared by all entities in accordance with the generally accepted accounting principles prevailing in the jurisdiction of which the entity is a part.
1. Balance Sheet
It indicates the position of the assets, liabilities, and equity of the entity as on the last date of any reporting period. It measures the financial position and strength of the entity on a particular date. Assets and liabilities are further classified as current and non-current. Sometimes the items of assets and liabilities are presented in the order of their liquidity when the same is required by the accounting standards.
2. Income Statement
The income statement reflects the financial results of an entity over a particular reporting period by the way of profits or losses. The net profits or losses after tax are calculated after subtracting all expenses and taxes incurred from the revenues and other income earned for a particular period. Further, it also shows the income that is attributable to each stock holder by way of EPS.
3. Cash Flow Statement
This statement indicates the sources of cash inflows and the application of such cash inflows by way of cash outflows by the entity over the reporting period. It shows the cash flows from operating, investing, and financing activities. The statement helps to track the movement of cash and cash equivalents over the reporting period.
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4. Notes to Financial Statements
Notes to financial statements contain additional relevant information that is not contained in other financial statements. It contains the bifurcation of items that are presented in the other statements and also such information that could not be recorded in such other statements since they could not be quantified or did not qualify for reporting there.
5. Statement of Changes in Equity
It represents the movement in shareholders’ equity over the reporting period during various events. Apart from showing the net profit or loss attributable to the shareholders, it also accounts for changes in capital reserves, distributions to the shareholders, items directly recognized in equity, and the effect of changes in accounting policies or prior period items.
Financial Statements Analysis
Financial statements can be analyzed by the stakeholders to make investment related decisions. Investors and market analysts use the financial statements to understand the position of the financial health of a company, its financial performance, and capability. On the other hand, the management analyzes the statements to monitor the financial affairs of the company.
The statements of the current reporting period can be compared against the statements of the past periods and forecasts to understand the performance of the company. The techniques that are used for analyzing financial statements include horizontal analysis, vertical analysis, and ratio analysis. They help a user to understand the profitability as well as the liquidity of the company based on which the investors can decide whether the company is worth investing in or not.
Financial Statements vs Financial Reporting
Financial reporting is a process through which information is provided to the stakeholders of the company so that they can take decisions accordingly. By way of financial reporting, the various stakeholders are presented with financial information with respect to the company at regular intervals.
On the other hand, financial statements are the financial records that are prepared and issued by the company as a part of the financial reporting requirements. They represent the financial health of the company and are prepared as per the prescribed accounting standards.
Advantages
Financial statements offer the following advantages.
- It contains useful information about the earnings and financial position of the company. This information helps the users of the financial statements to understand the financial performance of the company and its trends as compared to last year. This helps them to forecast the future profitability of the company and accordingly take investing decisions.
- They help to understand the position of debts and assets in a company and how the company is managing its debt.
- It helps in ratio analysis which is an important tool of analysis of financial statements and helps the users to draw meaningful information.
Limitations
There are some limitations attached to financial statements.
- Forecasting based on present financial statements can be risky. This is because the financial performance of a company is subject to fluctuations in the industry.
- The financial statements do not account for the effect of inflation.
- The statements are usually prepared for a specific period like one year. Due to this, they do not reflect the individual seasonal impact on the business.
- It sometimes becomes difficult to compare the statements of two companies belonging to the same industry if they adopt different accounting policies.
Conclusion
Financial Statements are usually prepared on a yearly basis. However, sometimes companies also prepare half-yearly financial statements. They help the stakeholders to understand the performance of the company based on which they form their decisions.
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