Financial statements (or financial reports) are formal records of a business' financial activities.
British English, including United Kingdom company law, financial statements are often referred to as accounts, although the term financial statements is also used, particularly by accountants.
Financial statements provide an overview of a business' financial condition in both short and long term. There are four basic financial statements: [ [http://www.iasplus.com/standard/ias01.htm "Presentation of Financial Statements"] Standard IAS 1, International Accounting Standards Board. Accessed 24 June 2007.]
Balance sheet: also referred to as statement of financial position or condition, reports on a company's assets, liabilities, and net equity as of a given point in time.
Income statement: also referred to as Profit and Loss statement (or a "P&L"), reports on a company's income, expenses, and profits over a period of time.
Statement of retained earnings: explains the changes in a company's retained earnings over the reporting period.
Statement of cash flows: reports on a company's cash flow activities, particularly its operating, investing and financing activities.
For large corporations, these statements are often complex and may include an extensive set of
notes to the financial statementsand management discussion and analysis. The notes typically describe each item on the balance sheet, income statement and cash flow statementin further detail. Notes to financial statements are considered an integral part of the financial statements.
Purpose of financial statements
"The objective of financial statements is to provide information about the financial position, performance and changes in financial position of an enterprise that is useful to a wide range of users in making economic decisions." [ [http://www.iasplus.com/standard/framewk.htm "The Framework for the Preparation and Presentation of Financial Statements"] International Accounting Standards Board. Accessed 24 June 2007.] Financial statements should be understandable, relevant, reliable and comparable. Reported assets, liabilities and equity are directly related to an organization's financial position. Reported income and expenses are directly related to an organization's financial performance.
Financial statements are intended to be understandable by readers who have "a reasonable knowledge of business and economic activities and accounting and who are willing to study the information diligently." [ [http://www.iasplus.com/standard/framewk.htm "The Framework for the Preparation and Presentation of Financial Statements"] International Accounting Standards Board. Accessed 24 June 2007.]
*Owners and managers require financial statements to make important business decisions that affect its continued operations.
Financial analysisare then performed on these statements to provide management with a more detailed understanding of the figures. These statements are also used as part of management's annual report to the stockholders.
*Employees also need these reports in making
collective bargainingagreements (CBA) with the management, in the case of labor unionsor for individuals in discussing their compensation, promotion and rankings.
2. External Users: are potential investors, banks, government agencies and other parties who are outside the business but need financial information about the business for a diverse number of reasons.
investorsmake use of financial statements to assess the viability of investing in a business. Financial analyses are often used by investors and is prepared by professionals (financial analysts), thus providing them with the basis in making investment decisions.
*Financial institutions (banks and other lending companies) use them to decide whether to grant a company with fresh
working capitalor extend debt securities(such as a long-term bank loanor debentures) to finance expansion and other significant expenditures.
*Government entities (tax authorities) need financial statements to ascertain the propriety and accuracy of
taxes and other duties declared and paid by a company.
*Media and the general public are also interested in financial statements for a variety of reasons.
Government financial statements
The rules for the recording, measurement and presentation of
government financial statementsmay be different from those required for business and even for non-profit organizations. They may use either of two accounting methods: accrual accounting, or cash accounting, or a combination of the two. A complete set of chart of accountsis also used that is substantially different from the chart of a profit-oriented business
Audit and legal implications
Although the legal statutes may differ from country to country, an
auditof financial statements are usually, but not exclusively required for investment, financing, and tax purposes. These are usually performed by independent accountants or auditing firms. Results of the audit are summarized in an audit report that either provide an unqualified opinion on the financial statements or qualifications as to its fairness and accuracy. The audit opinion on the financial statements is usually included in the annual report.
There has been much legal debate over who an auditor is liable to. Since audit reports tend to be addressed to the current shareholders, it is commonly thought that they owe a legal duty of care to them. But this may not be the case as determined by common law precedent. In Canada, auditors are liable only to investors using a prospectus to buy shares in the primary market. In the
United Kingdom, they have been held liable to potential investors when the auditor was aware of the potential investor and how they would use the information in the financial statements. Nowadays auditors tend to include in their report liability restricting language, discouraging anyone other than the addressees of their report from relying on it. Liability is an important issue: in the UK, for example, auditors have unlimited liability.
United States, especially in the post- Enronera there has been substantial concern about the accuracy of financial statements. Corporate officers (the chief executive officer(CEO) and chief financial officer(CFO)) are personally liable for attesting that financial statements "do not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by th [e] report." Making or certifying misleading financial statements exposes the people involved to substantial civil and criminal liability. For example Bernie Ebbers(former CEO of WorldCom) was sentenced to 25 years in federal prison for allowing WorldCom's revenues to be overstated by $11 billion over five years.
tandards and regulations
Different countries have developed their own accounting principles over time, making international comparisons of companies difficult. To ensure uniformity and comparability between financial statements prepared by different companies, a set of guidelines and rules are used. Commonly referred to as
Generally Accepted Accounting Principles(GAAP), these set of guidelines provide the basis in the preparation of financial statements.
Recently there has been a push towards standardizing accounting rules made by the
International Accounting Standards Board("IASB"). IASB develops International Financial Reporting Standardsthat have been adopted by Australia, Canada and the European Union(for publicly quoted companies only), are under consideration in South Africaand other countries. The United States Federal Accounting Standards Boardhas made a commitment to converge the U.S. GAAP and IFRS over time.
Inclusion in annual reports
To entice new investors, most public companies assemble their financial statements on fine paper with pleasing graphics and photos in an annual report to shareholders, attempting to capture the excitement and culture of the organization in a "marketing
brochure" of sorts. Usually the company's chief executive will write a letter to shareholders, describing management's performance and the company's financial highlights.
In the United States, prior to the advent of the internet, the annual report is considered the most effective way for corporations to communicate with individual shareholders.
Blue chipcompanies went to great expense to produce and mail out attractive annual reports to every shareholder. The annual report was often prepared in the style of a coffee table book.
Center for Audit Quality(CAQ)
Financial statement analysis
Government financial reports
* [http://financialstatementschool.com Practical information on financial statements and financial analysis]
* [http://accountinginfo.com/study/fs/fs-101.htm Invaluable and complete guide to creating and understanding financial statements]
* [http://www.sec.gov/answers/infomatters.htm SEC.gov - Information matters]
* [http://highered.mcgraw-hill.com/sites/dl/free/007353062x/443425/ros3062x_Ch03.pdf Working with Financial Statements]
* [http://highered.mcgraw-hill.com/sites/dl/free/007353062x/443425/ros3062x_Ch02.pdf Financial Statement]
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