Importance Of Financial Statements Top 10 Reasons

Importance of Financial Statements

In this article, we provide the list of top 10 important financial statements –

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#1 Importance of the Balance Sheet

The balance sheet shows the company’s financial position and provides detailed investments of the company’s asset investments. The balance sheet also contains the company’s debt and equity levels. This capital mix helps investors and creditors understand the position and the company’s performance.

There are differences in reporting various items in IFRS and US GAAP. For example, long-lived assets, inventory, intangible assetsIntangible AssetsIntangible Assets are the identifiable assets which do not have a physical existence, i.e., you can’t touch them, like goodwill, patents, copyrights, & franchise etc. They are considered as long-term or long-living assets as the Company utilizes them for over a year. read more, leases, impairment of long lived assets as well as taxes

#2 Importance of Income Statement

The balance sheetBalance SheetA balance sheet is one of the financial statements of a company that presents the shareholders’ equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner’s capital equals the total assets of the company.read more is a snapshot of the company’s assets, liabilities, equity, and debt. It does not show what happened in the period that caused the company to get to the position where it is now. Therefore, profit figures on the income statement are importantIncome Statement Are ImportantThe income statement is one of the company’s financial reports that summarizes all of the company’s revenues and expenses over time in order to determine the company’s profit or loss and measure its business activity over time based on user requirements.read more to the investors.

Income statement formatIncome Statement FormatThe standard format for preparing a company’s income statement starts with the sales revenue figure of the business and then adds other income to it. After deducting all business expenses from the total amount of revenue and other income generated, the net profit/loss of the business organization is determined.read more contains sales, expenses, losses, and profit. Using these statements can help investors evaluate the company’s past performance and determine future cash flows.

IFRS and US GAAP also differ in the classification of certain expenses like restructuring chargesRestructuring ChargesRestructuring Cost is the one-time expense incurred by the company in the process of reorganizing its business operations. It is done to improve the long term profitability and working efficiency. This expenditure is treated as the non-operating expenses in the financial statements.read more, shipping costs, and handling costs. The necessary expense of depreciationDepreciationDepreciation is a systematic allocation method used to account for the costs of any physical or tangible asset throughout its useful life. Its value indicates how much of an asset’s worth has been utilized. Depreciation enables companies to generate revenue from their assets while only charging a fraction of the cost of the asset in use each year. read more and discontinued operations are also treated very differently.

#3 Importance of Cash Flow Statement

Cash flow statementCash Flow StatementA Statement of Cash Flow is an accounting document that tracks the incoming and outgoing cash and cash equivalents from a business.read more shows the inflow and the outflow of the cash flow in and out of business during the financial period. It gives the investors an idea that the company has enough funds to pay for its expenses and purchases.

The cash flow statement has all three main headings, i.e., Operating, Investing, and Financing. It gives the business an overview of the entire business.

Under the US GAAP, interest received and paid will be a part of operating activities, while under IFRS, interest received will be a part of operating or investing activities. Interest paid will be a part of operating or financing activitiesFinancing ActivitiesThe various transactions that involve the movement of funds between the company and its investors, owners, or creditors in order to achieve long-term growth are referred to as financing activities. Such activities can be analyzed in the financial section of the company’s cash flow statement.read more. Similarly, under US GAAP dividends received will be a part of operating activitiesOperating ActivitiesOperating activities generate the majority of the company’s cash flows since they are directly linked to the company’s core business activities such as sales, distribution, and production.read more while dividends paid will be a part of financing activities, and under IFRS, dividends received will be a part of operating activities while dividends paid will be a part of the financing.

#4 Importance of the Statement of Equity

It is primarily important to the equity shareholders because it shows the changes in the components like retained earnings during the periodRetained Earnings During The PeriodRetained Earnings are defined as the cumulative earnings earned by the company till the date after adjusting for the distribution of the dividend or the other distributions to the investors of the company. It is shown as the part of owner’s equity in the liability side of the balance sheet of the company.read more. The difference between equity and debt shows the companies net worthCompanies Net WorthThe company’s net worth can be calculated using two methods: the first is to subtract total liabilities from total assets, and the second is to add the company’s share capital (both equity and preference) as well as reserves and surplus.read more.

A company with a steady increase in retained earnings is sustainable as opposed to increasing shareholderShareholderA shareholder is an individual or an institution that owns one or more shares of stock in a public or a private corporation and, therefore, are the legal owners of the company. The ownership percentage depends on the number of shares they hold against the company’s total shares.read more base.

#5 To the Management

The complexities and the size of the business make it necessary for the management to have up-to-date, accurate, and detailed information about the business and its financial position. The financial position helps the management understand the company’s performance in comparison to the other businesses and the sector.

Providing management with accurate information enables them to form proper policies for the companies and make correct decisions.

These statements rank the performance of management. The performance of these statements will help management justify their work to all the parties involved in the business.

#6 To the Shareholders

Shareholders are the business owners but do not take part in making decisions and day-to-day activities. However, these results are shared with the shareholders at the AGM AGM AGM stands for annual general meeting. It is an official gathering of the stockholders and directors of an incorporated company in every calendar year to ensure that there is 100 percent compliance concerning all the lawful requirements like preparation and presentation of its financial statements.read more held annually.

These statements enable the shareholders to understand how the company has been performing. It also allows them to judge the present and future performance

Financial statements are the most important source of information for current and prospective customers. They also need it to understand the dividend payout ratioDividend Payout RatioThe dividend payout ratio is the ratio between the total amount of dividends paid (preferred and normal dividend) to the company’s net income. Formula = Dividends/Net Incomeread more and forecast the future dividends

#7 To the Creditors and the Lenders

Factors like liquidityLiquidityLiquidity is the ease of converting assets or securities into cash.read more, debt, and profitability are all judged by the essential metrics in the financial statements. Creditors and Lenders are most concerned about the company’s debt position. If the debt level is higher than the other companies in the same industry, it means that the company is over-leveraged

Analyzing these statements will help them decide if they want to continue and determine their future course of action.

#8 To the Employees

Some companies present different financial statements for their employees. Employees need business information for mainly two reasons: their current wage and future salary appraisals. They will be interested in knowing the current condition as well as the future earnings

#9 To the Government

Another importance of financial statements is that the government uses financial statements for taxation purposes. The government uses the business performance of these companies in various sectors to assess the economies’ performance.

#10 To the Company

Debt Management

Debt can cripple the progress of any company, no matter which sector the company belongs to. Ratios like debt to equity, interest coverage ratioInterest Coverage RatioThe interest coverage ratio indicates how many times a company’s current earnings before interest and taxes can be used to pay interest on its outstanding debt. It can be used to determine a company’s liquidity position by evaluating how easily it can pay interest on its outstanding debt.read more, debt service charge, etc., help the management make important decisions related to debt.

Trend Analysis

Trend analysisTrend AnalysisTrend analysis is an analysis of the company’s trend by comparing its financial statements to analyze the market trend or analysis of the future based on past performance results, and it is an attempt to make the best decisions based on the results of the analysis done.read more of the future metrics and identify the trend of both past and present. It will help the business understand the company’s current weakness and overall health.

Tracking

Liability Management

If the company wishes to borrow any money, it can look at the current liabilitiesCurrent LiabilitiesCurrent Liabilities are the payables which are likely to settled within twelve months of reporting. They’re usually salaries payable, expense payable, short term loans etc.read more by using the financial statements. Business loans and credit cards are liabilities that the company must consider before applying for other loans.

Compliance

All public companies must publish financial statements quarterly or annually. Hence to also be compliant with the government norms, it is necessary to publish these statements.

There are also differences in the balance sheet and income statement layout. There is no specific requirement for balance sheets and income statements; however, public companies must follow the particular guidelines as per the regulation by the SEC. In the case of IFRS, there is no prescribed layout but has a limitation on the number of line items.