Financial Statements

When a student has studied for a year, he/she wants to know how much he/she has learnt during
that period. Similarly, every business enterprise wants to know the result of its activities of a
particular period which is generally one year and what is its financial position on a particular date
which is at the end of this period. For this, it prepares various statements which are called the
financial statements

A financial statement is a collection of data organized according to logical and consistent accounting
procedures. Its purpose is to convey an understanding of some financial aspects of a business firm.
It may show a position at a moment in time, as in the case of a balance sheet, or may reveal a
series of activities over a given period of time, as in the case of an income statement.

Meaning of Financial Statements

Financial statements are basically reports that depict financial and accounting information relating to
businesses. A company’s management uses it to communicate with external stakeholders. These
include shareholders, tax authorities, regulatory bodies, investors, creditors, etc.

The financial statements of a company reflect a true picture of its financial performances. They depict

not only profits and losses, but even assets and liabilities. It is only at the end of all accounting

processes that we can generate financial statements. Let’s take a look at the objectives of financial
statements along with their features. (i) The position statement or the balance sheet; and

(ii) The income statement or the profit and loss account.

These statements are used to convey to management and other interested outsider the profitability
and financial position of a firm.

Financial statements are the outcome of summarizing process of accounting. In the words of John

N. Myer, “The financial statements provide a summary of the accounts of a business enterprise, the

balance sheet reflecting the assets, liabilities and capital as on a certain date and the income

statement showing the results of operations during a certain period.” Financial statements are
prepared as an end result of financial accounting and are the major sources of financial information
of an enterprise.
Smith and Asburne define financial statements as, “the end product of financial accounting in a set

of financial statements prepared by the accountant of a business enterprise-that purport to reveal

the financial position of the enterprise, the result of its recent activities, and an analysis of what has
been done with earnings.”

Financial statements are also called financial reports. In the words of Anthony ” Financial

statements, essentially, are interim reports, presented annually and reflect a division of the life of an
enterprise into more or less arbitrary accounting period-more frequently a year.”

Financial statements are the basis for decision making by the management as well as other
outsiders who are interested in the affairs of the firm such as investors, creditors, customers,
suppliers, financial institutions, employees, potential investors, government and the general public.

Nature of Financial Statements:

The financial statements are prepared on the basis of recorded facts. The recorded facts are those

which can be expressed in monetary terms. The statements are prepared for a particular period,

generally one year. The transactions are recorded in a chronological order, as and when the events
happen.

The accounting records and financial statements prepared from these records are based on

historical costs. The financial statements, by nature, are summaries of the items recorded in the
business and these statements are prepared periodically, generally for the accounting period.

The American Institute of Certified Public Accountants states the nature of financial statements as

“Financial Statements are prepared for the purpose of presenting a periodical review of report on

progress by the management and deal with the status of investment in the business and the results

achieved during the period under review. They reflect a combination of recorded facts, accounting
principles and personal judgments.”

The American Accounting Association expresses in its statement, “Every corporate statement

should be based on accounting principles which are sufficiently uniform, objective and well
understood to justify opinions as to the condition and progress of business enterprise. Its basic

assumption was that the purpose of periodic financial statements of a corporation is to furnish
information that is necessary for the formation of dependable judgments.”

(1) Recorded facts concerning the business transactions,

(2) Conventions adopted to facilitate the accounting technique,

(3) Postulates, or assumptions made to and

(4) Personal judgments used in the application of the conventions and postulates.”

The following points explain the nature of financial statements:

1. Recorded Facts:

The term ‘recorded facts’ refers to the data taken out from the accounting records. The records are

maintained on the basis of actual cost data. The original cost or historical cost is the basis of

recording various transactions. The figures of various accounts such as cash in hand, cash in bank,

bills receivables, sundry debtors, fixed assets etc. are taken as per the figures recorded in the

accounting books. The assets purchased at different times and at different prices are put together

and shown at cost prices. As recorded facts are not based on replacement costs, the financial
statements do not show current financial condition of the concern.

2. Accounting Conventions:

Certain accounting conventions are followed while preparing financial statements. The convention

of valuing inventory at cost or market price, whichever is lower, is followed. The valuing of assets at
cost less depreciation principle for balance sheet purposes is followed.

The convention of materiality is followed in dealing with small items like pencils, pens, postage

stamps, etc. These items are treated as expenditure in the year in which they are purchased even

though they are assets in nature. The stationery is valued at cost and not on the principle of cost or
market price whichever is less. The use of accounting conventions makes financial statements
comparable, simple and realistic.
3. Postulates:

The accountant makes certain assumptions while making accounting records. One of these

assumptions is that the enterprise is treated as a going concern. The other alternative to this

postulate is that the concern is to be liquidated, this, is untenable if management shows an intention

to liquidate the concern. So the assets are shown on a going concern basis. Another important
assumption is to presume that the value of money will remain the same in different periods.

Though there is a drastic change in purchasing power of money the assets purchased at different

times will be shown at the amount paid for them. While preparing profit and loss account, the

revenue is treated in the year in which the sale was undertaken even though the sale price may be
received in a number of years. The assumption is known as realization postulate.

4. Personal Judgments:

Even though certain standard accounting conventions are followed in preparing financial statements

but still personal judgment of the accountant plays an important part. For example, in applying the

cost or market value whichever is less to inventory valuation the accountant will have to use his

judgment in computing the cost in a particular case. There are a number of methods for valuing

stock, viz.; last in first out, first in first out, average cost method, standard cost, base stock method,
etc.

The accountant will use one of these methods for valuing materials. The selection of depreciation

method, to use one of the several methods for estimating uncollectible debts, to determine the

period for writing off intangible assets are some of the examples where judgment of the accountant
will play an important role in choosing the most appropriate course of action.

Uses of Financial Statements:

George O. May points out the following major uses of financial statements:
(1) As a report of stewardship;

(2) As a basis for fiscal policy;

(3) To determine the legality of dividends;

(4) As guide to advise dividend action;

(5) As a basis for the granting of credit;

(6) As informative for prospective investors in an enterprise;

(7) As a guide to the value of investment already made;

(8) As an aid to government supervision;

(9) As a basis for price or rate regulation;

(10) As a basis for taxation

Thus, the term ‘financial statements’ generally refer to the two statements:

Financial statements basically include the following reports:

1. Balance sheet

2. Profit and Loss statement

3. Cash flow statement

Nature of Financial Statements

Financial statements are prepared using facts relating to events, which are recorded chronologically.
We have to first record all these facts in monetary terms. Then, we have to process them using all
applicable rules and procedures. Finally, we can now use all this data to generate financial statements

Based on this understanding, the nature of financial statements depends on the following points:

1. Recorded facts: We need to first record facts in monetary form to create financial statements.
For this, we need to account for figures of accounts like fixed assets, cash, trade receivables,
etc.

2. Accounting conventions: Accounting Standards prescribe certain conventions applicable in

the process of accounting. We have to apply these conventions while preparing financial
 statements. For example, valuation of inventory at cost price or market price, depending on
whichever is lower.

3. Postulates: Apart from conventions, even postulates play a big role in the preparation of
financial statements. Postulates are basically presumptions that we must make in accounting.
For example, the going concern postulate presumes a business will exist for a long time. Hence,
we have to treat assets on a historical cost basis.

4. Personal judgments: Even personal opinions and judgments play a big role in the preparation
of financial statements. Thus, we have to rely on our own estimates while calculating things like
depreciation.

History of Financial Statements

 Most people know from their own experience that finance is considered a difficult and
confusing subject, especially for those who do not work with it every day. Few people know
that the first balance sheet was created during the late Middle Ages with the income
statement coming along a few years later (the cash statement only became required in the
late 1980s). How can something so old and critical to understanding and managing business
still be so broadly misunderstood? Let’s take a brief look at where the statements come from
to see if it sheds any light on the topic.

 A brief history of accounting…

 As you may be aware, the earliest business transactions took place through barter and trade
(e.g., I give you three chickens for one goat). This form of transacting was originated and
settled on the spot, thus, tracking transactions was not necessary. However, much of the
transactions that occur in business today take place on credit (usually 30 days on account),
introducing the need to track what you have and what you owe.

 The earliest known tracking of goods took place in Mesopotamia in cities along the Tigris
Euphrates river valley, some 10,000 years ago, where active trading took place between
towns and cities up and down the rivers. Many of the same problems that businesses face
today existed for merchants at this time. Trade involved shipping goods up and down the
rivers, requiring merchants to trust a boatman with their goods. As you might imagine,
disagreements were common about what was shipped and what was received on the other
end. So merchants decided they needed a way to track the goods shipped. All of this,
however, took place before writing and numbers were even invented (and you thought
accounting was confusing today!).

 In place of writing and math, merchants made clay tokens in various shapes with different
markings to identify their products. Before sending the goods, a token for each item would be
encased in a ball of clay, which would then be dried in the sun and given to the boatman. The
boatman would then deliver the clay ball to the buyer on the other end of the transaction, who
would match the tokens with the items in the delivery and verify that everything was
accounted for. Fortunately, for us, writing and numbers were invented, but I’m not so sure
their invention made accounting any easier for us to understand!
Modern-day accounting and the primary financial statements
Various forms of bookkeeping or account tracking have been traced throughout history, with the
earliest known official account book dating back to 1211. However, around the time the explorers
were setting sail for the Americas, a new form of accounting was invented. Although a man named
Benedikt Kotruljevic is credited as the original inventor of (or earliest to document the principals of)
double-entry accounting, it was Luca Pacioli, whose manifesto was widely reprinted, that is
regarded as the leader of this technique and is considered the “father of accounting.” During this
time period, there was a growing acceptance of commercial activity leading to a greater need to
efficiently track commercial proceedings. Such account documents were needed for legal security,
employee control and to remember the transactions that occurred.

Take, for example the exploration of Christopher Columbus or other adventurous sailors that set sail
to exploit the riches of the new world. Investors in these explorations wanted ways to track their
investment. It was through this kind of activity, where accounts were not immediately settled, that
the balance sheet was derived. The intention was (and still is) to provide a snap shot of what a
business has and what it owes at a moment in time.

The balance sheet, however, does not provide the details that explain exactly how profits were
generated. So, investors wanted to know how much income their business ventures created relative
to their expense. The desire to better understand profitability lead to the invention of the income
statement.

Modern accounting still follows the principles of these systems some 500 years later

 Objectives of Financial Statements

Financial statements are prepared to ascertain the profits earned or losses incurred by a
business concern during a specified period and also to ascertain its financial position at the
end of that specified period.

Financial statements are generally of two types (a) Income statement which comprises of
Trading Account and Profit & Loss Account, and (b) Position Statement i.e., the Balance
Sheet.

Following are the objectives of preparing financial statements: -

Ascertaining the results of business operations

Every businessman wants to know the results of the business operations of his enterprise
during a particular period in terms of profits earned or losses incurred. Income statement
serves this purpose.

Ascertaining the financial position

Financial statements show the financial position of the business concern on a particular date
which is generally the last date of the accounting period. Position statement i.e. Balance
Sheet is prepared for this purpose.

Source of information

Financial statements constitute an important source of information regarding finance of a

business unit which helps the finance manager to plan the financial activities of the business
and making proper utilisation of the funds.
Helps in managerial decision making

The Manager can make comparative study of the profitability of the

concern by comparing the results of the current year with the results of
the previous years and make his/her managerial decisions accordingly.

An index of solvency of the concern

Financial statements also show the short term as well as long term
solvency of the concern. This helps the business enterprise in borrowing
money from bank and other financial institutions and/or buying goods on
credit.

Stakeholders of a company heavily rely on financial statements to understand its functioning. They
portray the true state of affairs of the company. Here are some objectives of financial statements:

 Financial statements show an accurate state of a company’s economic assets and liabilities.
External stakeholders like investors and authorities generally do not possess this information
otherwise.

 They help in predicting the extent of a company’s capacity to earn profits. Shareholders and
investors can use this data to make their financial decisions.

 Financial statements of a company depict the effectiveness of its management. How well a
company is performing depends on its profitability, which these statements show.

 They even help readers of these statements know the accounting policies used in them. This
helps in understanding statements more comprehensively.

 These statements also provide information relating to the company’s cash flows. Investors and
creditors can use this data to predict the company’s liquidity and cash requirements.

 Finally, financial statements explain the social impact of businesses. This is because it shows
how the company’s external factors affect its functioning.
There are four main financial statements
OTHETR OBJECTIVES
After studying this lesson you will be able to :
• explain the meaning and the objectives of financial statements;
• classify the financial statements into Trading and Profit & Loss
Account and Balance Sheet;
• distinguish between capital expenditure and revenue expenditure,
capital receipts and revenue receipts;
• explain the purpose of preparing Trading Account and Profit and
Loss Account;
• draw the format of Trading Account and Profit and Loss Account;
• explain the Balance Sheet
They are types of financial statements

: (1) balance sheets; (2) income statements; (3) cash flow statements; and
(4) statements of shareholders’ equity. Balance sheets show what a company owns and
what it owes at a fixed point in time. Income statements show how much money a
company made and spent over a period of time. Cash flow statements show the
exchange of money between a company and the outside world also over a period of
time. The fourth financial statement, called a “statement of shareholders’ equity,” shows
changes in the interests of the company’s shareholders over time.

 Balance Sheets

 A balance sheet provides detailed information about a

company’s assets, liabilities and shareholders’ equity.
 Assets are things that a company owns that have value. This typically means
they can either be sold or used by the company to make products or provide
services that can be sold. Assets include physical property, such as plants,
trucks, equipment and inventory. It also includes things that can’t be touched but
 nevertheless exist and have value, such as trademarks and patents. And cash
itself is an asset. So are investments a company makes.

 Liabilities are amounts of money that a company owes to others. This can
include all kinds of obligations, like money borrowed from a bank to launch a new
product, rent for use of a building, money owed to suppliers for materials, payroll
a company owes to its employees, environmental cleanup costs, or taxes owed
to the government. Liabilities also include obligations to provide goods or
services to customers in the future.

 Shareholders’ equity is sometimes called capital or net worth. It’s the money that
would be left if a company sold all of its assets and paid off all of its liabilities.
This leftover money belongs to the shareholders, or the owners, of the company.

The following formula summarizes what a balance sheet shows:

ASSETS = LIABILITIES + SHAREHOLDERS' EQUITY
A company's assets have to equal, or "balance," the sum of its
liabilities and shareholders' equity.

 A company’s balance sheet is set up like the basic accounting equation shown
above. On the left side of the balance sheet, companies list their assets. On the
right side, they list their liabilities and shareholders’ equity. Sometimes balance
sheets show assets at the top, followed by liabilities, with shareholders’ equity at
the bottom.
 Assets are generally listed based on how quickly they will be converted into
cash. Current assets are things a company expects to convert to cash within one
year. A good example is inventory. Most companies expect to sell their inventory
for cash within one year. Noncurrent assets are things a company does not
expect to convert to cash within one year or that would take longer than one year
to sell. Noncurrent assets include fixed assets. Fixed assets are those assets
used to operate the business but that are not available for sale, such as trucks,
office furniture and other property.

 Liabilities are generally listed based on their due dates. Liabilities are said to be
either current or long-term. Current liabilities are obligations a company expects
to pay off within the year. Long-term liabilities are obligations due more than one
year away.


 Shareholders’ equity is the amount owners invested in the company’s stock plus
or minus the company’s earnings or losses since inception. Sometimes
 companies distribute earnings, instead of retaining them. These distributions are
called dividends.
 A balance sheet shows a snapshot of a company’s assets, liabilities and
shareholders’ equity at the end of the reporting period. It does not show the flows
into and out of the accounts during the period.

 Income Statements
 An income statement is a report that shows how much revenue a company
earned over a specific time period (usually for a year or some portion of a year).
An income statement also shows the costs and expenses associated with
earning that revenue. The literal “bottom line” of the statement usually shows the
company’s net earnings or losses. This tells you how much the company earned
or lost over the period.
 Income statements also report earnings per share (or “EPS”). This calculation
tells you how much money shareholders would receive if the company decided to
distribute all of the net earnings for the period. (Companies almost never
distribute all of their earnings. Usually they reinvest them in the business.)
 To understand how income statements are set up, think of them as a set of
stairs. You start at the top with the total amount of sales made during the
accounting period. Then you go down, one step at a time. At each step, you
make a deduction for certain costs or other operating expenses associated with
earning the revenue. At the bottom of the stairs, after deducting all of the
expenses, you learn how much the company actually earned or lost during the
accounting period. People often call this “the bottom line.”
 At the top of the income statement is the total amount of money brought in from
sales of products or services. This top line is often referred to as gross revenues
or sales. It’s called “gross” because expenses have not been deducted from it
yet. So the number is “gross” or unrefined.
 The next line is money the company doesn’t expect to collect on certain sales.
This could be due, for example, to sales discounts or merchandise returns.
 When you subtract the returns and allowances from the gross revenues, you
arrive at the company’s net revenues. It’s called “net” because, if you can
imagine a net, these revenues are left in the net after the deductions for returns
and allowances have come out.
 Moving down the stairs from the net revenue line, there are several lines that
represent various kinds of operating expenses. Although these lines can be
reported in various orders, the next line after net revenues typically shows the
costs of the sales. This number tells you the amount of money the company
spent to produce the goods or services it sold during the accounting period.
 The next line subtracts the costs of sales from the net revenues to arrive at a
subtotal called “gross profit” or sometimes “gross margin.” It’s considered “gross”
because there are certain expenses that haven’t been deducted from it yet.
 The next section deals with operating expenses. These are expenses that go
toward supporting a company’s operations for a given period – for example,
salaries of administrative personnel and costs of researching new products.
Marketing expenses are another example. Operating expenses are different from
“costs of sales,” which were deducted above, because operating expenses
cannot be linked directly to the production of the products or services being sold.
 Depreciation is also deducted from gross profit. Depreciation takes into account
the wear and tear on some assets, such as machinery, tools and furniture, which
are used over the long term. Companies spread the cost of these assets over the
periods they are used. This process of spreading these costs is called
depreciation or amortization. The “charge” for using these assets during the
period is a fraction of the original cost of the assets.
 After all operating expenses are deducted from gross profit, you arrive at
operating profit before interest and income tax expenses. This is often called
“income from operations.”
 Next companies must account for interest income and interest expense. Interest
income is the money companies make from keeping their cash in interest-bearing
savings accounts, money market funds and the like. On the other hand, interest
expense is the money companies paid in interest for money they borrow. Some
income statements show interest income and interest expense separately. Some
income statements combine the two numbers. The interest income and expense
are then added or subtracted from the operating profits to arrive at operating
profit before income tax.
 Finally, income tax is deducted and you arrive at the bottom line: net profit or net
losses. (Net profit is also called net income or net earnings.) This tells you how
much the company actually earned or lost during the accounting period. Did the
company make a profit or did it lose money?

 Earnings Per Share or EPS
 Most income statements include a calculation of earnings per share or EPS. This
calculation tells you how much money shareholders would receive for each share
of stock they own if the company distributed all of its net income for the period.
 To calculate EPS, you take the total net income and divide it by the number of
outstanding shares of the company.

 Cash Flow Statements
 Cash flow statements report a company’s inflows and outflows of cash. This is
important because a company needs to have enough cash on hand to pay its
expenses and purchase assets. While an income statement can tell you whether
 a company made a profit, a cash flow statement can tell you whether the
company generated cash.
 A cash flow statement shows changes over time rather than absolute dollar
amounts at a point in time. It uses and reorders the information from a company’s
balance sheet and income statement.


 The bottom line of the cash flow statement shows the net increase or decrease in
cash for the period. Generally, cash flow statements are divided into three main
parts. Each part reviews the cash flow from one of three types of activities:
(1) operating activities; (2) investing activities; and (3) financing activities.

 Operating Activities
 The first part of a cash flow statement analyzes a company’s cash flow from net
income or losses. For most companies, this section of the cash flow statement
reconciles the net income (as shown on the income statement) to the actual cash
the company received from or used in its operating activities. To do this, it
adjusts net income for any non-cash items (such as adding back depreciation
expenses) and adjusts for any cash that was used or provided by other operating
assets and liabilities.

 Investing Activities
 The second part of a cash flow statement shows the cash flow from all investing
activities, which generally include purchases or sales of long-term assets, such
as property, plant and equipment, as well as investment securities. If a company
buys a piece of machinery, the cash flow statement would reflect this activity as a
cash outflow from investing activities because it used cash. If the company
decided to sell off some investments from an investment portfolio, the proceeds
from the sales would show up as a cash inflow from investing activities because
it provided cash.

 Financing Activities
 The third part of a cash flow statement shows the cash flow from all financing
activities. Typical sources of cash flow include cash raised by selling stocks and
bonds or borrowing from banks. Likewise, paying back a bank loan would show
up as a use of cash flow.


Financial Statement Ratios and Calculations

You’ve probably heard people banter around phrases like “P/E ratio,” “current ratio” and
“operating margin.” But what do these terms mean and why don’t they show up on
financial statements? Listed below are just some of the many ratios that investors
calculate from information on financial statements and then use to evaluate a company.
As a general rule, desirable ratios vary by industry.
If a company has a debt-to-equity ratio of 2 to 1, it means that the company has two
dollars of debt to every one dollar shareholders invest in the company. In other words,
the company is taking on debt at twice the rate that its owners are investing in the
company.
Inventory Turnover Ratio = Cost of Sales / Average Inventory for the Period

If a company has an inventory turnover ratio of 2 to 1, it means that the company’s

inventory turned over twice in the reporting period.
Operating Margin = Income from Operations / Net Revenues

Operating margin is usually expressed as a percentage. It shows, for each dollar of

sales, what percentage was profit.
P/E Ratio = Price per share / Earnings per share

If a company’s stock is selling at $20 per share and the company is earning $2 per
share, then the company’s P/E Ratio is 10 to 1. The company’s stock is selling at 10
times its earnings.

Working Capital = Current Assets – Current Liabilities

 Debt-to-equity ratio compares a company’s total debt to shareholders’ equity. Both of

these numbers can be found on a company’s balance sheet. To calculate debt-to-
equity ratio, you divide a company’s total liabilities by its shareholder equity, or
 Inventory turnover ratio compares a company’s cost of sales on its income statement
with its average inventory balance for the period. To calculate the average inventory
balance for the period, look at the inventory numbers listed on the balance sheet.
Take the balance listed for the period of the report and add it to the balance listed for
the previous comparable period, and then divide by two. (Remember that balance
sheets are snapshots in time. So the inventory balance for the previous period is the
beginning balance for the current period, and the inventory balance for the current
period is the ending balance.) To calculate the inventory turnover ratio, you divide a
company’s cost of sales (just below the net revenues on the income statement) by
the average inventory for the period, or
 Operating margin compares a company’s operating income to net revenues. Both of
these numbers can be found on a company’s income statement. To calculate
operating margin, you divide a company’s income from operations (before interest
and income tax expenses) by its net revenues, or
 P/E ratio compares a company’s common stock price with its earnings per share. To
calculate a company’s P/E ratio, you divide a company’s stock price by its earnings
per share, or
 Working capital is the money leftover if a company paid its current liabilities (that is,
its debts due within one-year of the date of the balance sheet) from its current assets.
Bringing It All Together
Although The above details discusses each financial statement separately, one should
keep in mind that they are all related. The changes in assets and liabilities that you see
on the balance sheet are also reflected in the revenues and expenses that you see on
the income statement, which result in the company’s gains or losses. Cash flows
provide more information about cash assets listed on a balance sheet and are related,
but not equivalent, to net income shown on the income statement. And so on. No one
financial statement tells the complete story. But combined, they provide very powerful
information for investors. And information is the investor’s best tool when it comes to
investing wisely.

IMPORTANCE OF FINACIAL STATEMENTS:-

Importance Of Financial Statements:

The utility of financial statements to different parties is discussed in detail as

follows:
(1) Management:

The financial statements are useful for assessing the efficiency for different cost

centres. The management is able to exercise cost control through these statements.

The efficient and inefficient spots are brought to the notice of the management. The
management is able to decide the course of action to be adopted in future.

(2) Creditors:

The trade creditors are to be paid in a short period. This liability is met out of current

assets. The creditors will be interested in current solvency of the concern. The

calculation of current ratio and liquid ratio will enable the creditors to assess the current
financial position of the concern in relation to their debts.

(3) Bankers:

The banker is interested to see that the loan amount is secure and the customer is also

able to pay the interest regularly. The banker will analyze the balance sheet to

determine financial strength of the concern and profit and loss account will also be
studied to find out the earning position.

A banker has a large number of customers and it is not possible to supervise their

business activities. It is through the financial statements that a banker can keep a watch

on the business plans and performances of its customers. These statements also help

the banker to determine the amount of securities it will ask from the customers as a
cover for the loans.

(4) Investors:

The investors include both short-term and long-term investors. They are interested in

the security of the principal amount of loan and regular interest payments by the

concern. The investors will study the long-term solvency of the concern with the help of
financial statements. The investors will not only analyze the present financial position
but will also study future prospects and expansion plans of the concern. The possibility

of paying back the loan amount in the face of liquidation of the concern is also taken
into consideration.

(5) Government:

The financial statements are used to assess tax liability of business enterprises. The

government studies economic situation of the country from these statements. These

statements enable the government to find out whether business is following various

rules and regulations or not. These statements also become a base for framing and
amending various laws for the regulation of business.

(6) Trade Associations:

These associations provide service and protection to the members. They may analyze

the financial statements for the purpose of providing facilities to these members. They
may develop standard ratios and design uniform system of accounts.

(7) Stock Exchange:

The stock exchanges deal in purchase and sale of securities of different companies.

The financial statements enable the stock brokers to judge the financial position of

different concerns. The fixation of prices for securities, etc., is also based on these
statements.

Financial reports represent information base for business decision making.

Management of the company is focused on the perception of future events as a result of
the present decision, while accounting is ex post oriented. The requirements of users of
financial information condition the level and form of desired information. Relationship
between accounting and enterprise management are significant and multiple because it
is the effects of management decisions that assess the financial statements, which are
the product of accounting of companies in which are processed all business decisions
that was made by management. Analysis as the process of testing and evaluating in
terms of methodology, which is biased and overlap, based on the assumption: that the
assessment (synthesis) is the completion of the analysis, which is preceded by testing
methodology developed which provides a basis of the individual elements which are
combined into a single synthesis of a logical statement. In other words, the method of
which is in the process of analyzing the induction, is coming to that knowledge by
processing the deduction. The process of testing and assessment in the analysis of
business has its own specific test methods that are based on known theoretical and
scientific scheme. Financial analysis is used to assess relationships between items
within the financial statements. This scientific work points to the role and significance of
the results provided by the financial analysis for business decision making.

A company’s financial statements provide financial information that investors, creditors

and analysts use to evaluate a company’s financial performance. A good deal of the
information presented in a financial report is required by law or by accounting
standards. Your company's financial statements are important tools for senior managers
to communicate past successes as well as future expectations. By publishing financial
statements, management can communicate with interested outside parties, such as
investors, the news media and industry analysts about its accomplishments running the
company.

Financial Conditions of a Company

A company’s financial conditions are of a major concern to investors and creditors. As

sources of finance for your company operations, investors and creditors rely on financial
reports to gauge conditions for both the safety and profitability of their investments.
More specifically, investors and creditors need to know where their money went and
where it is now.

Your financial balance sheet addresses such issues by providing detailed information
about the company’s asset investments. The balance sheet also lists a company’s
outstanding debt and equity components, and so debt and equity investors can better
understand their relative positions in a company’s capital mix.
Reporting on Operating Results

Financial conditions shown on the balance sheet are snapshots of a company’s assets,
liabilities and equity at the end of a financial reporting period; they don’t reveal what
happened during the period from operations that may have caused changes to financial
conditions. Therefore, operating results during the period also concerns investors. The
financial statement of income statement reports operating results such as sales,
expenses and profits or losses. Using the income statement, investors can both
evaluate a company’s past income performance and assess the uncertainty of future
cash flows.
Importance of the Cash Flow Statement

The importance of the cash flow statement is that it shows the exchange of cash
between a company and the outside world during a period, and so investors can know if
the company has enough cash to pay for expenses and asset purchases. The company
profits reported in the income statement can be difficult to interpret and most likely
contain certain non-cash elements, providing no direct information on a company’s cash
exchange during the period.

Moreover, a company also incurs cash inflows and outflows during a period from other
non-operating activities, namely investing and financing. To investors, cash from all
sources, not just accounting income from operations, is what pays back their
investments.
Statement of Shareholders’ Equity

The statement of shareholders’ equity is especially important to equity investors

because it shows the changes in various equity components, including retained
earnings, during a period. The amount of shareholders’ equity is a company’s total
assets minus its total liabilities, representing the company’s net worth. A steady growth
in a company’s shareholders’ equity by way of increasing retained earnings, as opposed
to expanding shareholder base, means the accumulation of investment returns for
current equity shareholders.