Financial Statement: Introduction and Analysis
What is a Financial Report or Financial Statement?
Financial statements or the financial reports are the formal records of the financial activities carried out in business.
The financial statements are the written records that convey the financial activities and conditions of a business organization. The main aim of financial statements is to present the financial information of the entity in question in a clear and concise manner. There are four major components of financial statements that include: income statements, balance sheets, statements of retained earnings and cash flows. In order to ensure precision and accuracy, the financial statements are audited by government agencies, accountants, firms etc.
Why is a Financial Statement Important?
Financial Statement is a comprehensive report on the health of the business. The financial statement determines if a business has the capability to pay back the loans if it has the cash flow to meet bills and purchase stock. It also tells the source from where the business is producing cash.
The financial report helps in determining if the business is profitable, and will stay the same. The financial statements give an overall view of the condition of the business and if there are any risks associated with the business.
The financial reports are helpful for the following reasons:
- Determining the ability of the business to produce cash
- Determining if a business has the competency to pay back its debts
- Keeping a track of financial results
- Derive financial ratios from the statements that help in indicating the condition of the business
- Investigating the details of various business transactions
Objectives and Importance of Financial Reports
- Knowing the profitability of the business
Financial statements help in ascertaining if the business is earning enough profit and to find out if the profits have increased or decreased in comparison to that of the previous year.
- Knowing the solvency of the business
With the help of financial statements, you can analyze the position of the business with regards to the capacity of the entity to pay back the short and long term liabilities.
- Judging the growth of the business
By comparing the data of present and the past year of a business entity, a meaningful decision can be drawn with regard to the growth of the business.
- Judging financial strength of the business
Financial statements help a business entity to determine its solvency and helping to find out if it is capable of purchasing assets from its own resources.
- Forecasting and Preparing Budgets
Financial reports provide the details regarding the weak areas of the business so that the management is able to take corrective measures to eradicate the short comings.
- Communicating with Different Parties
Financial statements are prepared by the organizations to communicate with different parties telling them about the financial position. Thus, it can be said that for successful management of the commercial enterprise, preparation of financial statements is an important step.
What is Financial Statement Analysis?
Financial Statement Analysis refers to the process of analyzing the financial statements of the company for the purpose of right decision making and to understand the overall health of the firm. The financial statements record financial data, that must be evaluated by financial statement analysis. This is further helpful for the investors, shareholders, managers, and other interested parties.
Importance of Financial Statement Analysis
The financial statement analysis is necessary for various reasons:
- Holding of shares
Shareholders are the owners of the company. They may have to take decisions if they want to continue with the holdings or sell them out. The financial statement analysis is important as it helps in providing meaningful information to the investors to take right decisions.
- Decisions and plans
It is the responsibility of the management of the company to take decisions and further formulate plans for future. Thus, it is always important to evaluate the performance and effectiveness of the company. For that purpose, financial statement analysis is important to the management of the company.
- Extension of credit
The creditors are the loan providers to the company. Thus, they have to take decisions on whether they have to extend their loans and demand for higher rates of interests. The important information related to this is provided through a financial statement analysis.
- Investment decision
The potential investors are the ones who have surplus capital to invest in some profitable task. hence, they often need to make a decision if they could invest their capital in the shares of the business. In order to make the right decision making, the financial statement analysis is important as it helps in providing useful information.
Despite the above mentioned advantages, there are many disadvantages of the financial statement analysis:
- Based on past data
In the financial statements of the company, only the previous year’s data is included. Furthermore, the future is not like the past. Thus, the analysis of financial statements doesn’t provide a basis for future approximation, accounting, and scheduling.
- Problem in comparability
The size of a concerned business organization varies according to the volume of transactions. Hence, the figures of different financial statements lose the characteristic of comparability.
- No assessment of managerial ability
The results of the financial statement analysis must not be taken as an indication of a good or bad management. This means that the managerial ability cannot be assessed by the analysis.