Financial Statements are documents of a company formulated most likely at year-end for a business or an individual and are to state the financial position of a firm as precise as possible for both the user and the owner (CIMA, 2012). The financial statements include balance sheet, income statements, cash flows, statement of retained earnings and other statements.
Financial statements help one to know whether a company is making or losing money. Whether a company is profitable or not. Management and stockholders would want to see the company’s profits to be certain of continuity of the business while customer would want to know whether the company is in a position to meet their future orders (CIMA, 2012). Investors will use the financial statements to know whether the company can meet their debts in time.
Financial statements contain information that helps management to make its decision. With the financial statements, management can decide which decisions to after careful examination of the financial statements. Understanding of financial statements helps us to analyze, challenge numbers and interpret the numbers so as to understand the direction in which the business is flowing to.
Key information that the financial statements relay include profitability, liquidity, leverage and the entity performance as compared to other years or other firms. This information is required for efficient management of the company and relevant decision-making. Financial statements help a company to know its position as compared to other firms after analyzing of the above information.
Financial statements are prepared according to various strict procedures such as General Accepted Accounting Principles (GAAP) and International Accounting Standards (IAS) (CIMA, 2012).
Use of such procedures allows use of a common language allowing comparison of financial statements between firms over a period. Use of a common language limits the forging of the documents as there are laid down rules and procedures that state how the documents should be created and the format to be written in. As these financial statements are to be audited by statutory authorities, it is a recommendation by law to use these accepted principles in the formulation of the financial statements to enable easier processes in auditing.
Use of financial statements by companies is compulsory according to law so as to enable auditing and payment of appropriate taxes. Financial statements are designed in such a way that they do not allow flexibility. Such flexibilities give loopholes for fraud cases to occur hence not permitted by countries such as England which is International Accounting Standards (IAS). Countries such as United States of America (USA) use the US’s system (US GAAP) which allows for flexibility of financial statements. It is this allowance of the flexibility in formation of financial statements that lead to the great recession in the company. As seen, allowance of flexibility has its advantages and disadvantages hence one should be careful regarding the standards to use in the formulation of the statements. Flexibility of the standards helps in changing of the standards with change in time allowing of fast adoption in the books.
Financial ratios are used in accounting in the analysis of financial information to come up with simplified data that can be easily understandable. The management uses them as well as shareholders, lenders, creditors, customers and the government in the analysis of the business. Different stakeholders have different uses for the financial ratios. There are different groups of financial ratios and this are liquidity ratios, profitability ratios, debt ratios, operating performance ratios, cash flow indicators ratios and investment valuation ratios. These ratios measure different aspects in the financial statements thereby providing all the required information by each of the stakeholders of the firm. The main function of financial statement is that they offer a benchmark for comparative analysis. Other functions include judging efficiency in term of its management and operations, locating its weakness and strength as well after analyzing of its overall performance, formulating plans and analyzing financial statements.
Investors use the financial ratios to analyze the company’s performance comparing it with other firms of the same industry so as to know whether it is profitable to invest or not (Aguinis, 2010). Investors analyses the profitably, liquidity, debtness and the investment evaluation of the company at hand, this enables investors to be able to decide the best company to invest in which will result in maximum dividends to them.
It is not advisable to compare firms which are not on the same industry as different industries have different layouts and plans and different acceptable profitability levels, for example one cannot compare a company processing fish and a mining company, the two industries have different payment periods and different investment portfolios, this implies that companies cannot be compared from others of different industries (Aguinis, 2010).
In summary, use of financial information is of utmost importance in the management of an entity. They enable a company to be able to analyze its performance and to meet the various statutory regulations enforced. Financial ratios are devised from financial statements and are easier to use. This makes them efficient in decision making by the various stakeholders of the company
Aguinis, H. (2010). Performance management. Upper Saddle River, N. J: Pearson Prentice Hall.
Chartered Institute of Management Accountants (2012). Performance management. London: BPP Learning Media Ltd.