Financial Statements

Financial Statements

Table of Contents

Meaning of Financial Statements

Financial statements are basically reports that depict financial and accounting information relating to businesses. A company’s management uses it to communicate with external stakeholders. These include shareholders, tax authorities, regulatory bodies, investors, creditors, etc.

These statements basically include the following reports:

  1. Balance sheet
  2. Profit and Loss statement
  3. Statement of cash flow
  4. Income sheet

Objectives of Financial Statements

Stakeholders of a company heavily rely on financial statements to understand its functioning. They portray the true state of affairs of the company. Here are some objectives of financial statements:

  • These statements show an accurate state of a company’s economic assets and liabilities. External stakeholders like investors and authorities generally do not possess this information otherwise.
 
  • They help in predicting the extent of a company’s capacity to earn profits. Shareholders and investors can use this data to make their financial decisions.
 
  • These statements depict the effectiveness of a company’s management. How well a company is performing depends on its profitability, which these statements show.
 
  • They even help readers of these statements know the accounting policies used in them. This helps in understanding statements more comprehensively.
 
  • These statements also provide information relating to the company’s cash flows. Investors and creditors can use this data to predict the company’s liquidity and cash requirements.
 
  • Finally, they explain the social impact of businesses. This is because it shows how the company’s external factors affect its functioning.

Types of Financial Statements

There are four (4) types of financial statements that are required to be prepared by an entity. These statements are :

  1. Income statement,
  2. Balance Sheet or Statement of financial position,
  3. Statement of cash flow,
  4. Noted (disclosure) to financial statements.

Let us discuss these statements in detail now

Income statement

Income statement of an organisation or business entity is the financial statement which contains financial information about the three important components, which are revenues, profit or loss and expenses incurred during the accounting period.

 

The three components of income statement are explained as follows:

  1. Revenues: It refers to the sales of goods and services that the business generates during the current accounting period. Revenues can be obtained from both cash and credit sales.
  2. Profit or Loss: Profit or loss is the net income which is obtained by deducting the expenses from the revenues. Profit will happen if revenues are more than expenses and loss will occur if expenses are more than revenue.
  3. Expenses: Expenses are the cost of operations that an organisation incurs for running day to day operations. They can be administrative expenses like salaries, depreciation etc.

 

Balance sheet

A balance sheet is known as a statement of financial position as it shows the position of assets, liabilities and equity at the end of an accounting period. The net worth of a business can be determined by deducting the liabilities from the assets.

Statement of Cash Flow

Cash flow statement reveals the movement of cash in an organisation. It comprises cash inflows and outflows. Cash flow can be classified into three activities which are operating activities, investing activities and financing activities.

Scope of Financial Management

Financial management helps a particular organisation to utilize their finances most profitably. 

 

This is achieved via the following two conducts.

 

The scope of financial management is divided into two categories:

  • Traditional Approach 
  • Modern Approach 

 

Let us discuss the two approaches in brief.

Traditional Approach

According to this approach,the scope of financial function is restricted to procurement of funds by the corporate organizations to meet their financial needs.

 

The term procurement here refers to raising of funds externally as well as the interdependent aspects of raising funds.

 

 

The following three points were used

(i) Institutional sources of finance.

(ii) Issue of financial devices to collect refunds from the capital market.

(iii) Accounting and legal relationship l between the source of finance and business.

Limitations of Traditional Approach
One-sided approach- 

It is more considerate towards the fund procurement and the issues related to their administration, however, it pays no attention to the effective utilization of funds.

Gives importance to the Financial Problems of Corporations-

 It only focuses on the financial problems of corporate enterprises, so it narrows the opportunity of the finance function.

 

Attention to Irregular Events- 

It provides funds to irregular events like consolidation, incorporation, reorganization, and mergers, etc. and does not give attention to everyday business operations.

More Emphasis on Long Term Funds- 

It deals with the issues of long-term financing. 

Modern Approach to Finance Function

The modern approach had a more comprehensive analytical viewpoint with a focus on the procurement of funds and its active and optimum use. The fund arrangement is an essential feature of the entire finance function.

 

The main elements of this approach are an evaluation of alternative utilization of funds, capital budgeting, financial planning, ascertainment of financial standards for the business success, determination of cost of capital, working capital management, Management of income, etc. 

 

The three critical decisions taken under this approach are.

(i) Investment Decision

(ii) Financing Decision

(iii) Dividend Decision 

Investment Decision

This decision is related to the selection of assets in which finds will be invested by the firms. The asset that is acquired by a firm may be a long term asset or short term asset. 


The decision taken to invest the funds in long term assets is known as capital budgeting decision. Hence, capital budgeting is the process of selecting assets or an investment proposal that yields return for a long term.

Financing Decision

This scope of financial management indicates the possible sources of raising finances from various resources. 

 

Financial planning decisions attempt to estimate the sources and possible application of accumulated funds. A proper financial planning decision is crucial to ensure the availability of funds whenever required. 

Dividend Decision

It involves decisions taken with regards to net profit distribution. It is divided into two categories – Dividend for the shareholders.Retained profits (usually depends on a particular company’s expansion and diversification plans).

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