Financial statements are reports of an entity to provide its stakeholders with the necessary information for their decision-making needs. The term entity is used to describe any type of organization for which we do accounting e.g. a business, a company, a bank, a charity organization.
The objective of financial reporting is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders, and other creditors in making decisions about providing resources to the entity. The information explains the financial position of an entity at the end of a period (usually a year) and the financial performance of the entity over that period.
Responsibility For Preparing Financial Statements
Sole trader and partnership businesses
There may be no obligation to prepare financial reports, other than for tax purposes or obtaining a loan from a bank, for which the owner/partners are responsible. They might employ a person or persons to maintain the accounting records and prepare financial reports.
Companies
Companies must prepare financial reports for shareholders and for filing with relevant regulatory bodies. It is the responsibility of the directors to ensure that this is done. Usually, the work is delegated to employees.
Regulation For Preparing Financial Statements
Sole trader and partnership businesses
The financial reports are private and do not have to be disclosed, except to the tax authorities (and possibly also to a lending bank). These must be prepared according to accepted accounting principles and practices but need not conform to all the requirements of accounting standards.
Companies
The financial statements of a company are prepared for the shareholders of the company and are usually subject to audit. The audit is the examination of financial reports by an independent expert who expresses an opinion as to whether they are fairly presented (show a true and fair view).
Company law requires that financial statements be filed with a government agency, where they can be accessed and read by any general public member. Listed companies are even required to make their financial statements available on their websites.
The concepts, principles, conventions, laws, rules, and regulations used to prepare and present financial reports are Generally Accepted Accounting Principles (GAAPs).
GAAP AND IFRS
The main sources of GAAPs in Pakistani jurisdiction are:
- Companies Act, 2017; and
- International Financial Reporting Standards (IFRSs)
The accountancy profession has developed a large number of regulations and codes of practice that professional accountants are required to use when preparing financial reports. These regulations are accounting standards. Many countries and companies whose shares are traded on the world’s stock markets have adopted IFRSs issued by the International Accounting Standards Board (IASB).
Informational Needs Of Users Of Financial Statements
Financial statements are drafted to provide information that should be useful to most users but will not necessarily satisfy all of their needs.
Investors
They need information to assess whether to buy, hold, or sell investment in the business. Financial statements also indicate a company’s ability to pay dividends to its shareholders out of profits.
Lenders
Financial statements can help lenders to assess the continuing ability of the borrower to pay interest, and its ability to repay the loan principal at maturity.
Suppliers
They can use the financial statements to assess how much credit they might safely allow to the entity.
Government
They might use this information for business regulation or deciding taxation policies.
The public
In some cases, members of the general public might have an interest in the financial statements of a company. The IASB Framework comments: ‘For example, entities may make a substantial contribution to the local economy in many ways including the number of people they employ and their patronage of local suppliers.’
Employees
Employees need information about the financial stability and profitability of their employer. An assessment of profitability can help employees reach a view on the ability of the employer to pay higher wages or provide more job opportunities in the future.
Customers
Customers might be interested in the financial strength of an entity, especially if they rely on that entity for the long-term supply of key goods or services.
Managers
Management should have access to all the financial information they need, and in much more detail than financial statements provide. However, management is responsible for producing the financial statements and might be interested in the information they contain.
Frequently Asked Questions
What are financial reports?
Financial statements are written records that convey the business activities and the financial performance of a company. They are used by investors, creditors, and other stakeholders to assess a company’s financial health and make informed investment decisions.
What are the four main types of financial statements?
The four main types:
- Balance sheet: The balance sheet shows a company’s assets, liabilities, and equity at a specific point in time.
- Income statement: The income statement shows a company’s revenues and expenses over some time, such as a quarter or a year.
- Cash flow statement: The cash flow statement shows how a company’s cash position changed over some time.
- Statement of shareholders’ equity: The statement of shareholders’ equity shows changes in the interests of a company’s shareholders over time.
Why are financial statements important?
Financial statements are important because they provide stakeholders with a comprehensive view of a company’s financial health and performance. This information can be used to make informed investment decisions, assess a company’s creditworthiness, and evaluate a company’s management team.
How do I read financial statements?
Reading financial reports can be complex, but there are some basic concepts that investors should understand. Here are a few tips:
- Start with the balance sheet.
- Analyze the income statement.
- Review the cash flow statement.
- Compare the company to its peers.
 What are some common financial statement ratios?
There are many different financial statement ratios that investors can use to analyze a company’s financial performance. Here are a few of the most common:
- Profit margin
- Return on equity (ROE)
- Return on assets (ROA)
- Debt-to-equity ratio
- Current ratio
Where can I find financial statements?
Publicly traded companies are required to file their financial statements with the Securities and Exchange Commission (SEC). These statements can be found on the SEC’s website. Privately held companies are not required to file their financial statements with the SEC, but they may provide them to investors and creditors upon request.