Financial Statements – Definition and Meaning

Past events and performances serve as background for making projections if they are to be realistic. The financial statements provide important information  concerning past financial transactions and their effects om the  profitability and the financial position of the business. Various users of financial statements such as owners, investors, creditors, management etc. must make an analysis of financial statements to make right decision. Therefore financial statements are the means of conveying to owners, management or to interested outsiders a concise picture of profitability and financial position of the business. Financial statements are the end products of the  accounting process  which give a concise accounting information of the period after the accounting period is over.

Financial statements are the summary reports of a company’s financial transactions during a given period of time.

A firm communicates to the users through financial statements and reports.  The financial statements contain summarized information of the firm’s financial affairs, organized systematically. They report the end results of accounting activities during a given period of time. Financial statements provide the income or loss and financial position of a company. Financial statements are end of the period accounts prepared to show the profit or loss situation for a period of time and to assess the financial position and cash flow situation on a particular date. Financial statements report the result of past activities. Therefore, the are also called as the historical record of a company. Preparation of the financial statements is the responsibility of top management.   They should be prepared very carefully and contain as much information as possible.

Two basis financial statements prepared for external reporting to owners, investors and creditors are:

  1. Balance sheet (or statement of financial position):  Balance sheet contains information about resources and obligations of a business entity and about its owners’ interests in the business at a particular point of time. In accounting’s terminology, balance sheet communicates information about assets, liabilities and owner’s equity for a business firm as on a specific date.   It provides a snapshot of the financial position of the firm at the close of the firm’s accounting period.
  2. Profit and loss account (or income statement):  The profit and loss account presents the summary of revenues, expenses and net income (or net loss) of a firm for a period of time. Net income is the amount by which the revenues earned during a period exceed the expenses incurred during that period.

Other important financial statements are;

  1. Statement of Cash Flows: Management is interested in the cash inflows to the company and the cash outflows from the company, because they determine the company’s liquidity, its ability to pay its bills when due. The statement of cash flows shows the cash inflows and outflows from operating, investing and financing activities.
  2. Statement of Retained Earnings: The statement of retained earnings is also called as profit and loss appropriation account. One purpose of this statement is to connect the income statement and the balance sheet. The statement of retained earnings explains the changes in retained earnings between two balance sheet date. These changes usually consist of the addition of net income and the deduction of dividends.

More information is required for planning and controlling and therefore the financial accounting information is presented in different statements and reports in such a way as to serve the internal needs of management.   Financial statements are prepared from the accounting records maintained by the firm.

The following are the features of financial statements:

  1. Financial statements are always expressed in monetary terms. They ignore qualitative aspects. In other words, the non-monetary events do not come under the scope of financial statements.
  2. Financial statements are always prepared for a certain period of time. They generally cover the period of one year.
  3. Financial statements are historical in nature since they always present the past performance. Hence, they do not carry the futuristic approach.

The various objectives of financial statements are:

  1. To provide reliable financial information about economic resources and obligations of a business enterprise.
  2. To provide reliable information bout changes in the resources (resources minus obligations) of an enterprise that result from the profit-directed activities.
  3. To provide financial information that assists in estimating the earning potential of the enterprise.
  4. To provide other needed information about changes in economic resources and obligations.
  5. To disclose, to the extent possible, other information related to the financial statement that is relevant to statement users.

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