Post by Admin on Oct 30, 2014 22:06:38 GMT
DEFINITION OF FINANCIAL STATEMENTS
Financial statements are records that outline the financial activities of a business, an individual or any other entity. They are meant to present the financial information of the entity in question as clearly and concisely as possible for both the entity and for readers. A financial statement for businesses (or entities) usually includes:
• Statement of profit or loss and other comprehensive income
• Statement of financial position
• Statement of changes in equity
• Statement of cash flows and so on.
If financial statements would present the true and fair position of an entity at a specified date (or reporting date), the entity is expected to adhere strictly to generally accepted accounting principles (GAAP). In line with this, there should be absolute compliance with International Accounting standards (IASs) or International Financial Reporting Standards (IFRSs) and other local accounting standards.
The financial activities of an entity can be analyzed properly through the financial statements, presented by the entity. It should be noted that a meaningful assessment can only be done, if financial statements are prepared and presented in accordance with the International Accounting Standards (IAS or IFRS).
Readers of financial statements such as
• The employees
• The shareholders
• The management
• The government
• The customers
• The suppliers
• Members of the public etc.
Need financial statements to make economic decisions, since financial statements are produced to satisfy the requirements of external users.
The financial statements can be used to make the following economic decisions
• Decision to buy, hold or sell equity investment
• Assessment at management stewardship and accountability
• Assessment of the entity’s ability to pay employees
• Assessment of the security of amounts lent to the entity
• Determination of taxation policies
• Determination of distributable profits and dividend etc.
The aforementioned points made it clear that, the financial statements of entities also ‘speak’. In fact financial statements represent a major channel to assess the financial performance (and/or position) of an entity.
Therefore every financial statement must be thoroughly analyzed and interpreted before a reasonable economic decision can be made. However it is important to know that such economic decisions require taking actions in the future based on the present and past relevant financial data. That is, the financial statements ‘speak’ about the present and the past condition of an entity. This shows evidence that the financial statements have some limitations.
LIMITATIONS OF FINANCIAL STATEMENTS
• Financial statements represent the past – It’s important to remember that the financial statements represent the past performance of a company. Past performance carries no guarantee of future results i.e. they are based on historical costs and as such the impact of price level change is completely ignored.
• Financial statements ignore the qualitative aspects of running a company e.g. reputation and prestige of the business with the public, the efficiency and loyalty of the employees, integrity of management etc.
• Financial statements don’t directly show changes in the structure of the company – it is absolutely crucial to know about structural elements of a company that change. For instance, a company could have added a new plant, launched a new product, be preparing for an acquisition etc. However, the best source for this is the quarterly report that a company releases every quarter to detail its performance.
• Financial statements do not disclose the loss of major customers
• Financial statements do not disclose the competitive environment in which the company operates.
• No two companies even operating in the sane industry will have the same financial and business risk profile.
• In the first year of trading, there will be no comparative figures. So there will be no indication of whether or not a ratio is improving.
• Financial statements are subject to manipulations and so are the ratios based on them. Creative accounting is undertaken with key ratios in mind.
• Comparison against industry average may not be that revealing. A business may be subject to factors which are not common in the industry.
THE BROAD CATEGORIES OF RATIOS
Broadly specially, basis rations can be grouped late five categories
• Profitability and return
• Long-term solvency and stability
• Short-term solvency and stability
• Efficiency (turnover ratio)
• Shareholders’ investment ratio.
Financial statements are records that outline the financial activities of a business, an individual or any other entity. They are meant to present the financial information of the entity in question as clearly and concisely as possible for both the entity and for readers. A financial statement for businesses (or entities) usually includes:
• Statement of profit or loss and other comprehensive income
• Statement of financial position
• Statement of changes in equity
• Statement of cash flows and so on.
If financial statements would present the true and fair position of an entity at a specified date (or reporting date), the entity is expected to adhere strictly to generally accepted accounting principles (GAAP). In line with this, there should be absolute compliance with International Accounting standards (IASs) or International Financial Reporting Standards (IFRSs) and other local accounting standards.
The financial activities of an entity can be analyzed properly through the financial statements, presented by the entity. It should be noted that a meaningful assessment can only be done, if financial statements are prepared and presented in accordance with the International Accounting Standards (IAS or IFRS).
Readers of financial statements such as
• The employees
• The shareholders
• The management
• The government
• The customers
• The suppliers
• Members of the public etc.
Need financial statements to make economic decisions, since financial statements are produced to satisfy the requirements of external users.
The financial statements can be used to make the following economic decisions
• Decision to buy, hold or sell equity investment
• Assessment at management stewardship and accountability
• Assessment of the entity’s ability to pay employees
• Assessment of the security of amounts lent to the entity
• Determination of taxation policies
• Determination of distributable profits and dividend etc.
The aforementioned points made it clear that, the financial statements of entities also ‘speak’. In fact financial statements represent a major channel to assess the financial performance (and/or position) of an entity.
Therefore every financial statement must be thoroughly analyzed and interpreted before a reasonable economic decision can be made. However it is important to know that such economic decisions require taking actions in the future based on the present and past relevant financial data. That is, the financial statements ‘speak’ about the present and the past condition of an entity. This shows evidence that the financial statements have some limitations.
LIMITATIONS OF FINANCIAL STATEMENTS
• Financial statements represent the past – It’s important to remember that the financial statements represent the past performance of a company. Past performance carries no guarantee of future results i.e. they are based on historical costs and as such the impact of price level change is completely ignored.
• Financial statements ignore the qualitative aspects of running a company e.g. reputation and prestige of the business with the public, the efficiency and loyalty of the employees, integrity of management etc.
• Financial statements don’t directly show changes in the structure of the company – it is absolutely crucial to know about structural elements of a company that change. For instance, a company could have added a new plant, launched a new product, be preparing for an acquisition etc. However, the best source for this is the quarterly report that a company releases every quarter to detail its performance.
• Financial statements do not disclose the loss of major customers
• Financial statements do not disclose the competitive environment in which the company operates.
• No two companies even operating in the sane industry will have the same financial and business risk profile.
• In the first year of trading, there will be no comparative figures. So there will be no indication of whether or not a ratio is improving.
• Financial statements are subject to manipulations and so are the ratios based on them. Creative accounting is undertaken with key ratios in mind.
• Comparison against industry average may not be that revealing. A business may be subject to factors which are not common in the industry.
THE BROAD CATEGORIES OF RATIOS
Broadly specially, basis rations can be grouped late five categories
• Profitability and return
• Long-term solvency and stability
• Short-term solvency and stability
• Efficiency (turnover ratio)
• Shareholders’ investment ratio.