The Financial Statement is one of the important aspects of management and assumes huge importance in the life of a business. The financial statement refers to the statements released for showcasing the financial health of an organization. The statement provides complete details in an organized manner. What objectives does it serve? Here are our inputs for understanding the financial statement and its objectives.
What is a Financial Statement?
A Financial Statement reflects the true image of how a business is performing in terms of financial operations. In addition to the profits and losses suffered by the business, the financial statement also provides complete details of the assets and liabilities.
Financial statements are generally generated at the end of the financial year after all the accounting procedures are completed and duly audited. They are important enough for all the stakeholders to have a clear understanding of the proceedings of the organization along with its financial health. The financial statements are important for the stakeholders, and these include shareholders, creditors, investors, social investigators, government and other organizations for their interest.
The Financial Statements are available in multiple forms of the report –
- Balance sheet
- Profit and Loss statement and
- Cash Flow statement
The Financial statement is prepared based on the recorded events. These records are arranged in chronological order and form the basis of these statements. Objectives of Financial Statements
Some of the elements that a financial statement is dependent upon are
- Recorded Facts – Financial statements need the recorded facts for the sake of preparation. It takes into account, the recorded figures for fixed assets, cash, trade receivables, and similar other accounts.
- Postulates –Postulates form a huge role in the formulation of a financial statement. The postulates refer to the assumptions made for the sake of accounting. These are a few assumptions that are taken as self-evident principles.
- Personal Judgements –Personal opinions and judgments also have a saying in the preparation of the financial statements. Of course, the financial statements should be prepared based on the accounting principles, but personal judgment takes a major role in this context.
What are the Primary Objectives of Financial Statements?
A few critical Objectives of Financial Statements include the following. Of course, we will be focussing on the major objectives that the financial statement attempts to achieve.
1) Understanding the profitability of the business
The financial statement needs to have a clear understanding of whether the business is earning enough profit. It also focusses on understanding whether the profits have increased or decreased in comparison to the previous years.
In case the profits are moving southwards, the financial statement takes care of the corrective actions in case needed.
2) Taking care of business solvency
The financial statement also helps the authorities to analyze the exact position of the business in terms of financial security. The financial statement helps to understand the solvency of a business.
The solvency refers to the ability of the business to repay its short term and long term liabilities. It also helps you to take care of the efficiency of the business in taking proper care of the proper utilization of the resources.
3) Judging the business growth
Financial statements are prepared every year. It will help you compare two or more years of the statements and arrive at the financial health of the organization. This comparison will help you arrive at the right kind of conclusion with respect to the growth of the business.
It will also help you find if an increase in sales brings up equal profits for the business. It is the exact indication of the financial health of an organization. It will also help you arrive at the social impact of the business.
4) Forecasting and preparing the annual budget
Financial statement provides you access to the strength of the organization. You will have access to the weak spots of the business and assist you in taking the corrective action if any. The financial statement would help you remove the obstacles and take corrective action.
Knowledge of the weak spots and other issues will provide you input into the management issues if any. Based on the findings of the financial statement, you will be able to make necessary forecasts and preparation of budgets.
5) Effective Communication
The financial statement will be helpful in communicating the business health of the organization to the concerned parties. A business organization does not necessarily belong to promoters and the employees. There are several other people involved in the echelon who need to have access to the complete details of the organization.
A few of these stakeholders include shareholders, creditors, investors, social investigators, and government. Financial statements will be helpful in understanding the exact status that the business enjoys in terms of financial health.
Those were a few salient objectives that Financial Statements would attempt to achieve. Apart from these major objectives, you will also find that the Financial statements also have a few other minor objectives.
What are the Secondary Objectives of Financial Statements?
A few of the Objectives of Financial Statements need to focus on for a proper understanding of the business organization include-
- Evaluating the earning capacity of the firm. This can be achieved by providing the statement periodical earnings.
- Assist in making decisions related to acquisition, utilization, preservation, and distribution of resources and assets.
- Helping in expansion, growth and diversification plans for the organization. It can also help in assisting in the replacement of fixed assets.
- Providing the necessary details and data to the government. This will help take proper decisions related to taxation, duties and price controls.
- Taking the corrective actions with respect to the deviation between the projected and actual performances about the financial conditions.
- Assisting the internal management and the managers in formulating the internal policies and future courses of action.
- Building the confidence of the shareholders in the financial well being of the business.
- Assisting in addressing the disputes that may arise in the courts of justice.
- Helping the credit rating agencies in taking a call on the proper credit rating of the company.
Limitations of Financial Statements
While the objectives of financial statements are well understood in the above paragraphs, it should also be noted that it does suffer from a few inherent issues. Some of the limitations that the financial statements suffer from include
- Manipulation – Some business organizations can manipulate the information contained in the Financial Statements. This is normally done to hide the weaknesses or financial bad spots from the stakeholders.
- Diverse techniques and procedures – Financial statements do not have a standard procedure for their preparation. If two business organizations use diverse options, it may be difficult to compare them.
- Too much focus on Quantitative analysis – The information contained in the financial statements are dependent to a greater extent on the monetary elements. If there are some transactions that cannot be converted into monetary terms may not be added to the statements. Conflicts between any two departments cannot be included in the financial statement and thus will not provide a clear picture of the operating health of the business in its entirety.
Those were a few inputs into what precisely a Financial statement constitutes and what are the objectives behind making one. We are sure this article would have helped you understand the concept in detail.
Financial statements essentially constitute income statement and positional statement. Understanding them well enough should go a long way in promoting the financial health of your organization well ahead.