Shareholders, creditors or investors need reliable information in regards to the business financial performance. They can then make relevant conclusions on achieving targets and whether the firm is well managed. Investors may invest or not in the company and shareholders may decide if they still want to maintain their shares. Therefore relevant financial reporting exists.
Balance sheets
The balance sheet lists the organisation's assets and liabilities and gives an idea of the business financial position. A typical balance sheet is presented in figure below.
It represents the company's cash, inventory, property, plant and equipment and well as any other investments that company might have.
The liabilities side shows company's obligations to creditors which may be long- or short-term in nature. It shows what the company owes to someone else.
Shareholders capital ( Shareholders equity) is the difference between the company's assets and liabilities and it is the accounting measure of the company's net worth.
Assets = Liabilities + Shareholders equity.
The Income Statement
The income statement lists the company's revenues and expenses over a period of time. It lists the company's net income (or net profit) which is a measure of company's profitability during that period. A typical income statement is presented in figure below.
Where Balance Sheets shows the company's assets and liabilities at a given point of time, the Income Statement shows the flow of revenues that the company received in that period.
Gross sales (gross revenue or turnover) - total amount of revenue that the company received in that period.
Gross profit - is the profit that company earns.
Operating expenses - are the expenses from running the business.
Operating profit - is the profit from operations. Gross profit - operating expenses.
Net income - Profit/loss - total earnings of the company's shareholders.
The Statement of Cash Flows
The Statement of Cash Flows utilises the information from the income statement and the balance sheet to determine how much cash the company has generated and how the cash has been allocated during that period. It provides very valuable information for investors.
It is divided into 3 sections:
Operating activities - provides the net income from the income statement and adds all non-cash entries relating to company's activities
Investments activities - Lists the cash used for investments
Financing activities - shows the flow of cash between the business and its investors
Reporting Standards and Information Disclosure
Large businesses are generally owned by a group of people (shareholders) and tend to be managed by another group of people (executive directors, managers etc). Sometimes the shareholders are also directors the vast majority of the shareholders are not directly involved in the running of the business. They can only rely on financial information to monitor the financial performance and understand on whether the company is managed effectively. Creditors and investors also need these information.
Therefore, there need to be some sort of regulations around these financial statements. If the form and content of the statements was not regulated then the information may be misleading on the financial stance of the business. The financial statements of different companies could also be not comparable, therefore these regulations exists ( especially for large organisations). This is to ensure the information are accurate.
International reporting standards currently govern the structure of key financial reports. These are, for example:
IAS 1. Presentation of financial statements
IAS 7. Statements of cash flows
IAS 8. Accounting policies, changes in accounting estimates and errors
IAS 32. Financial instruments. Presentation
IAS 39. Financial instruments. Recognition and measurement
IFRS 1. First time adoption of IFRS
Limitations of the financial statements
We should be aware of the limitations of the financial statements when using the information.
These are Derived from historical costs. One concern when reviewing the Balance sheet is that the transactions are recorded at their costs as the values of liabilities and assets may change over time.
Are not adjusted to Inflation.
Do not contain some intangible assets. Some intangible assets are not recorded but but it records expenses to them which may underestimate the value of the business.
Only cover a specific period of time. Any reporting period may vary in operating results such as seasonal effects.
Often not comparable. Businesses use different accounting practices.
May be not accurate due to fraud.
Do not cover non-financial issues.
May not have been audited.
Have no predictable information.
Comments