2. What are Financial
Statements?
Financial Statements represent a proper and
formal record of the financial activities of an
organization. These are written reports that
evaluate the financial stability, performance
and liquidity of a company. Financial
Statements echo the financial effects of
business transactions and events on the
organization.
3. Basic Financial Statements
Three types of financial statements are selected by the accounting and
financial regulatory authorities:
1. Income statement:
How much money a company made last year.
It includes the followings:
Revenue, expense, profits over a year or quarter.
2. Balance sheet:
The current financial situation of the company.
a snap shot on a specific date of
Assets (value of what a company owns),
Liabilities (value of company's debts), and
Shareholder’s equity (the money invested by the company owners).
3. Cash flow statement:
How the cash came and went out of the company.
i.e. Cash received and cash spent by the company over a period of time.
4. Income Statement:
Income Statement, also known as the Profit and Loss
Statement, reports the company's financial performance in
terms of net profit or loss over a specified period. Income
Statement is composed of the following two elements:
• Income: What the business has earned over a period (e.g.
sales revenue, dividend income, etc)
• Expense: The cost incurred by the business over a period
(e.g. salaries and wages, depreciation, rental charges, etc)
Net profit or loss comes by deducting expenses from income.
5. Advantages:
The primary advantage of the income statement is
the information it gives on revenues.
The income statement provides information
concerning return on investment, risk, financial
flexibility, and operating capabilities.
The income statement is one of the most important
documents for investors looking to buy stock in a
particular company.
6. Drawbacks:
The major disadvantage of an income statement is
that it is considered as a fiction because it is based on
accrual accounting and it does not give the cash
transactions. Cash is king and free cash cannot be
calculated through income statement.
The income statement may be useful for gauging
earnings per share and other past financial data, but it
does not give much information about future
company success.
7.
8. Balance Sheet:
Balance Sheet, also known as the Statement of Financial
Position, presents the financial position of an organization at
a given date. It includes the following three elements:
Assets: Something a business owns or controls (e.g. cash,
inventory, plant and machinery, etc)
Liabilities: Something a business owes (e.g. creditors,
bank loans, etc)
Equity: What the business owes to its owners. This
represents the amount of capital that remains in the business
after its assets are used to pay off its outstanding liabilities.
Equity therefore represents the difference between the assets
and liabilities.
9. Advantages:
Balance Sheet helps to communicate information about the
financial position of the business at a particular moment in time.
It can give an indication of the financial strength of the
business and can also indicate the relative liquidity of the assets.
It also gives some information on the liabilities of the business
and when they will fall due. The combination of this information
can assist the user in evaluating the financial position of the
business.
It helps in comparison of assets and liabilities of business on
two dates to ascertain the progress being made by business.
10. Drawbacks:
One of the potential disadvantages of a balance sheet is that it
is only a financial snapshot of the condition of a company. This
means that it only take into consideration what is going onthat
moment with the business.
Another potential disadvantage of using a balance sheet is that
it does not tell you theaccurate value of a company.
One of the potential problems of using a balance sheet is that
this only evaluate a company financial factors. It doesn't evaluate
other factors that can add value to the business value.
11.
12. Cash Flow Statement:
Cash Flow Statement, presents the movement in cash and bank
balances over a period. The movement in cash flows is
classified into the following segments:
• Operating Activities: Represents the cash flow from primary
activities of a business.
• Investing Activities: Represents cash flow from the purchase
and sale of assets other than inventories (e.g. purchase of a
factory plant)
• Financing Activities: Represents cash flow generated or
spent on raising and repaying share capital and debt together
with the payments of interest and dividends.
13. Advantages:
It provides adequate information as regards to
the inflows and outflows of cash resources to
and from the enterprise.
It helps the management a lot for future cash
planning of the enterprise.
It evaluates the level of efficiency of the
management of the enterprise as regards to the
uses of its cash resources.
14. Drawbacks:
One of the potential disadvantages of the statement of cash flows is that it
does not take into consideration any future growth. When looking at the
statement of cash flows, you are essentially looking at information from the
past business operations.
Another potential problem with the statement of cash flows is that
interpreting data may be difficult. The information on a cash flow statement is
not necessarily easy to interpret. You can see where all of the cash flow is
going, but you may not know if it should be going there.
In isolation this is of no use and it requires other financial statements like
balance sheet, profit and loss etc and therefore limiting its use.
