by Michael Lodge
In an ongoing exercise to try and teach our clients and friends how to read and understand their business financial statements, and what their financial statement is used for – the purpose, I try and find good articles to help you learn. I found the following and it is a good explanation as to the purpose of financial statements. I would encourage you to sit down with your accountant or tax accountant and go over your financial statements before the year end. It is now close to two months before the year end. Be proactive and sit down and go over your financial statements with your accounting professional. If you don’t have an accountant or tax professional, call our office and make an appointment at: 877.778.1770
The general purpose of the financial statements is to provide information about the results of operations, financial position, and cash flows of an organization. This information is used by the readers of financial statements to make decisions regarding the allocation of resources.
At a more refined level, there is a different purpose associated with each of the financial statements. The income statement informs the reader about the ability of a business to generate a profit. In addition, it reveals the volume of sales, and the nature of the various types of expenses, depending upon how expense information is aggregated. When reviewed over multiple time periods, the income statement can also be used to analyze trends in the results of company operations.
The purpose of the balance sheet is to inform the reader about the current status of the business as of the date listed on the balance sheet. This information is used to estimate the liquidity, funding, and debt position of an entity, and is the basis for a number of liquidity ratios.
Finally, the purpose of the statement of cash flows is to show the nature of cash receipts and disbursements, by a variety of categories. This information is of considerable use, since cash flows do not always match the revenues and expenses shown in the income statement.
As a group, the entire set of financial statements can also be assigned several additional purposes, which are:
- Credit decisions. Lenders use the entire set of information in the financials to determine whether they should extend credit to a business, or restrict the amount of credit already extended.
- Investment decisions. Investors use the information to decide whether to invest, and the price per share at which they want to invest. An acquirer uses the information to develop a price at which to offer to buy a business.
- Taxation decisions. Government entities may tax a business based on its assets or income, and can derive this information from the financials.
- Owner & Management Decisions. It is vital that management look at their financial statements regularly with their accountant or tax accountant to plan for tax issues, reporting concerns for management or investor issues in their company. Try to really understand how your company is doing, the strengths and weaknesses.
In addition, financial statements can be presented for individual subsidiaries or business segments, to determine their results at a more refined level of detail.
In short, the financial statements have a number of purposes, depending upon who is reading the information and which financial statements are being perused.
Taken from Accounting Tools.