The financial statements of a company reveal the exact position of its financial performances. These statements are prepared at the end of all accounting process for a particular period. The internal users of financial statements are owners, managers, and employees. The external users of financial statements are banks, financial institutions, potential investors, tax authorities, suppliers, etc.
Financial statements contain the following reports:
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Profit & Loss A/c
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Income Sheet
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Balance Sheet
Use of Financial Statements
They play a major part in making financial decisions of a business. The main uses of financial statements are as follows:
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Assisting the Management
The financial statements exactly reflect the financial position of a company and thus bridge the gap between the management and the owners. Since the shareholders and the public can view the statements they can also watch the performance of the business.
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Availing Loans
Financial statements play a major role in availing loans or borrowing funds for better functioning. The lenders may be banks and various other financial institutions.
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Assessing the Finances
The financial statements are used to assess the company’s business, thereby figuring out the term of the company’s solvency.
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For the Government
The policies laid out by the government are based heavily on financial statements. They use a company’s financial statement to decide on taxation and other regulatory policies.
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For the Stock Exchanges
The financial statements are very much useful for regulatory bodies like various stock exchanges for so many reasons. They can assess a company’s internal matters using those statements whilst ensuring the protection of investors.
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Information on Investments
Mainly, the shareholders of a company depend on these statements only to know about their investments. This allows them to make more investments in case of profit, whereas to pull out in case of loss.
Limitations of Financial Statements
Investors should be well aware of the factors that they depend on to invest in or pull off from the business.
The following are the limitations of financial statements
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Dependence on historical costs
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Inflationary effects
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Intangible assets not recorded
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Based on a specific time period
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Not always comparable across companies
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Subject to fraud
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No discussion of non-financial issues
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Not verified
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No predictive value
After the limitations of financial statements, let’s now take a look at the P&L statement.
Profit & Loss Statement
This is one of the financial statements that are generated quarterly or annually. This statement summarizes the income gained and the expenses incurred for a particular period. The following is an example of a profit and loss statement.
One of the examples of Profit and Loss account is given below:
Uses of Trial Balance
A trial balance is a type of report which is prepared at the end of a financial period. This is generated before preparing the financial statements. The main purpose of preparing a trial balance is to find out accounting errors if any. Further to which needed adjustments are done to make prepare accurate financial statements.
The limitations of trial balance are:
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No proof of recorded transactions
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No proof of correct ledger entries
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Numerous errors may be found even though the columns are balanced
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Can miss out journal entries
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Cannot find ledger entries
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Cannot protect the repeated entries
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Cannot protect the offsetting errors
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Cannot protect the errors of principles
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Cannot protect the errors of commission
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Cannot protect the errors of omission
Uses of Balance Sheet
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To determine if working capital is enough
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To know the business net worth
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To see if the company can sustain the future operation
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To identify if there’s possible issuance of dividend
Limitations of Balance Sheet
The limitations to balance sheets are assets may be recorded at historical cost, using of estimates, and the omission of valuable assets.
Uses of Financial Statement Analysis
Financial statement analysis is used by all stakeholders whether internal or external, to figure out the performance of a business and value the same. All business entities create a balance sheet, income statement, and cash flow statement that are very important for financial statement analysis. It helps the government agencies to analyze the taxes owed to the firm.
Certain limitations of financial analysis are depreciation, the cost basis that excluded inflation, different accounting methods, unusual data, useful information, and a company’s diversification.