What are Financial Statements? : Objectives and Users of Financial Statements
Arjun EP
Meaning of Financial Statements
The summary of detailed information about financial position and performances of a business firm is known as the financial statement.
The financial statements are prepared at the end of accounting period.
The purpose for preparing financial statement is for the periodical review of the activities of the organization and results achieved by the organization.
It includes profit and loss account or income statement and balance sheet.
The income statement also may include manufacturing and trading account.
Profit and loss account indicates operation results of for a particular period.
Balance sheet indicates the financial position regarding assets, liabilities and capital.
Thus, financial statements are the strong form of accounting.
Meaning of Financial Statements Analysis
Financial statement analysis is the process of classifying, evaluating and interpreting the relationship between different heads of account or financial statements.
Financial statements analysis helps to know solvency and profitability position of the organization.
It provides information to management, shareholders, investors, creditors, lenders, employees, government agency and customers for following purpose:
Management prepares future action plan on the basis of financial information,
Shareholders are interested to know profitability position on the organization,
Investors want to know safety of their investment,
Creditors decide whether to supply goods on credit or not,
Lenders decide whether to grant loan or not,
Employees are interest about better bonus and increments,
Government agencies are interested for better information and tax on profit,
Customers are interested for better quality goods at reasonable price etc.
The main processes of financial statement analysis and interpretation are:
Re-arrangement of financial statement
Comparison of different elements of accounts
Analysis with reference to financial characteristics
Interpretation of financial information
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Accounting Equation |
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Basic Journal Entries in Nepali |
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Basic Journal Entries |
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Journal Entry and Ledger |
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Ledger |
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Subsidiary Book |
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Cash Book |
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Trial Balance & Adjusted Trial Balance |
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Bank Reconciliation Statement (BRS) |
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Depreciation |
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Adjustment in Final Accounts |
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Capital and Revenue |
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Non-Trading Concern |
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Government Accounting |
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Features or importance of Financial Statements
Financial statements are prepared from the accounting record maintained by the firm.
The accounting records are historical and expressed in terms of money.
So it is related to a period. It provides reliable information of business activities and their result.
It also provides information about resources of a business.
The main features of financial statements are as under:
Financial statements are concerned with past and so it is historical.
They are financial in nature and is expressed in terms of money.
Financial statements present the summary of revenue and expenses of a firm.
They show the financial position through the help of balance sheet.
Objectives of Financial Statements Analysis
The main objectives of financial statement analysis are given below:
To judge liquidity
Financial statement analysis helps to judge the short term solvency position of the company.
It can be determined by comparing the amount of current assets and current liabilities.
To judge solvency
Financial statements analysis supports to measure long term solvency position of the company.
It can be determined by comparing the long–term debts with shareholders fund and fixed assets.
To judge profitability
Financial statement analysis judges the profitability position of the company.
The amount of gross profit and net profit is compared with sales or assets.
It also helps to know net profit margin, return on investment, return on assets etc.
To help for planning and budgeting
Planning and budgeting should be prepared on the basis of past financial information.
Financial statement analysis helps for planning and budgeting for future performance.
To compare inter-company performance
Different users study comparative financial statements in different way.
They want to know strengths and weaknesses of the organization.
A financial statement analysis supports to make study of different ratios of the companies on the basis requirement.
Tools of Financial Statements Analysis
Financial statement analysis provides essential financial information to the shareholders, investors, creditors, lenders, employees, government agency and customers on the basis of their requirement.
According to situation and requirement, different financial tools can be used. Interested persons or organization use following tools on the basis of their requirement:
1. Ratio analysis
2. Cash flow analysis
3. Analysis of comparative financial statements
4. Trend analysis
Limitations of Financial Statements Analysis
Although financial statement analysis is important tool yet it has following limitations:
Only focus on quantity
Financial statements analysis does not consider and evaluate the quality like team work, dedicated employees, effective management, good relation between management and employees etc.
It provides only monetary information like profit and loss, solvency position, liquidity position etc.
Mislead to the users
In some cases, financial statement analysis misleads to its user.
When given information in financial statements are incorrect, users are misled for wrong decision.
Not useful for planning
Financial statements involve information of past performance of the company.
Therefore, historical information provides readymade information of past performance.
It is not useful for future planning.
Based on personal judgment
Financial statement analysis provides only information about liquidity, solvency, turnover and profitability position of past performance.
But, it does not provide readymade information to the managers to take right decision.
Managers need to use their personal skill and experience for taking decision.
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Accounting for Share |
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Share in Nepali |
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Debentures |
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Final Accounts: Class 12 |
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Final Accounts in Nepali |
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Work Sheet |
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Ratio Analysis (Accounting Ratio) |
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Fund Flow Statement |
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Cash Flow Statement |
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Theory Accounting Xii |
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Theory: Cost Accounting |
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Cost Accounting |
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LIFO−FIFO |
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Cost Sheet, Unit Costing |
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Cost Reconciliation Statement |
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Users of Financial Statements
There are different users of financial statements.
They look at the same financial statement from different angles.
Some users and their purposes of analysis to financial statements are given below.
Management
Managements take decision about new policy by analyzing the financial statements.
Managements can draw significant conclusion and determine.
It helps them in different ways for knowing the financial position, profitability and capital structure.
They use financial statement:
To ascertain the trend of profit of business.
To plan profits for the future.
To forecast the sales, purchases and different expenses on the basis of past data.
To determine liquidity position of the business.
To compare the efficiency of different employees, departments, policies and procedures.
To collect the different information for various decision making.
Investors of shareholders or owners
Every investor wants the safety of his/her investment.
Therefore, he/she would like to know whether the business is profitable or not.
He also wants to know about the growth potential of the business.
The growing potential of business helps in appreciation of the investment.
Analysis of the financial statement also helps to new investor for making decision on following query:
Which concern is more profitable?
Which concern will give him/her higher rate of dividend?
Where the investment should be made for safety?
Which concern will be better position to repay its debts in time?
Creditors
To know the fact and actual position of short term liquidity position, the creditors analyze the financial statement.
They are interested in knowing whether the concern will be able to pay their debts within time or not.
They can easily ascertain it by analyzing the financial statements.
Employees and trade union
Employee and trade unions are interested in their welfare.
They always want better wages, salary, bonus, better working conditions and security of their job.
For this purpose, they analysis the financial statement to know the profitability and financial condition of the organization.
They can ascertain form the analysis, how much bonus and wages are possible from the profits of the concern.
Bankers and lenders
Lenders include banks, insurance companies, unit trust, debenture-holders and suppliers of loans.
They are ready to provide finance if they get satisfaction with the financial condition of the concern.
So the analysis of financial statement helps them to determine whether their principals and the interest will be paid when due or not.
Stock exchange authority
Stock exchange authority analysis the financial statements to determine the market price of a company’s share.
The market price of the share can be determined on the basis of price earnings ratio and earnings per share.
Stock exchanges of SAARC are AFX (Afghanistan), DSX (Bangladesh), RSEBL (Bhutan), BSE (India), MSE (Maldives), NEPSE (Nepal), PSX (Pakistan), CSE (Sri Lanka).
Government
Government and government agencies like Central Statistical Organization are interested in financial statement.
They analyze it for compiling the industries account and national account.
For the purposes of assessment of excise duty, VAT and sales tax, the analysis of financial statements can be used by taxation authorities.
It is also helpful in operating the financial policies of the government.
Other parties
The financial statement helps some other parties such as economists, researchers, trade associations, journalists, consumer organization etc.
It provides essential information about the profitability efficiency, financial condition and future growth of the enterprise.
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