Financial statements are a set of documents that provides information about the financial position, operating performance and cash flows of a company or other organization.
They are usually prepared annually and are divided into three main categories:
- Income statement- shows the revenue and expenses for a given period of time (usually one year)
- Balance sheet- shows the assets, liabilities, and net worth at a given point in time
- Cash flow statement- shows the sources and uses of cash for a given period of time (usually one year)
Financial statements provide a snapshot of the financial health of a company. They are an excellent way to see how the company is performing in terms of its assets, liabilities, and equity. The balance sheet provides an overview of a company’s assets and liabilities on a given date. The income statement provides information about the company’s revenue and expenses for a specific time period. Finally, the cash flow statement is used to measure the cash inflow and outflow from different sources over time.
Government organizations, accounting companies, etc. frequently audit financial statements to guarantee accuracy for tax, financing, and investing purposes. Investors and financial analysts use financial data to examine a company’s performance and forecast its stock price for future operations. The annual report, which includes the company’s financial statements, is one of the most significant sources of trustworthy financial information. They also assess a company’s financial status and profit potential using its financial statements.
Importance of Financial Statements
Now, you may be wondering why companies need to go through such hectic procedures to prepare and analyze various financial statements. In this section, we’ll try to elaborate the importance of performing these actions, which are as follows;
Financial analysis helps you in producing projections, reports, and data models so that you can quickly make strategic decisions using the current and historical data available at your disposal. Companies can be one step ahead of their competitors by seizing quick opportunities for investment and growth that might otherwise be missed, with real-time insight and analysis.
Proper Debt Management
Debt management is a top priority for any company that wishes to sustain itself in the market for the long run. A company’s capacity to manage debt is greatly enhanced by having access to debt-related data, and people outside of businesses are also interested in harnessing the potential of financial reporting and analysis. Accurately tracking and analyzing the ratio of current assets to current liabilities, as well as the financial procedures associated with generating revenue and paying bills, like accounts receivable and accounts payable, makes it easier for companies to preserve short-term liquidity, plan long-term debt management, and alter workflows and processes to guarantee the highest possible return on every penny spent on debt repayment.
Financial Performance Optimization
The insights gained from evaluating financial data have immediate use in strategic planning and decision-making. However, those insights also have long-term significance since they show companies ways to improve their processes and gradually increase its speed, accuracy, and efficiency. Complete and accurate financial data contributes to the production of accurate financial statements that fully abide by all income tax laws and financial reporting standards. Hence, keeping up with tax obligations also becomes simpler by providing step-by-step transparent data along with simplifying the auditing and valuation process as well.
Cash Flow Management
It is said that about 82% of businesses fail due to poor cash flow management. By carefully reviewing their Key Performance Indicators, companies are able to go deeper into their income streams and liabilities to identify their present and future cash flow streams, develop plans to protect against unforeseen circumstances, and ensure funds on hand to capitalize on opportunities as they arise.
Improving Communication and Collaboration
By getting everyone on the same page and enabling teams to get started right away, real-time data analysis and sharing increases a company’s agility. Having a custom dashboard that lists all the important financial ratios like debt-to-equity ratio, return on assets, P/E ratio, working capital ratio, etc. makes it easier for companies to communicate with investors and creditors and also ensures them about the company’s transparency, accuracy, and compliance.
Reduction of Risk Exposure
Companies can reduce exposure to risks in a number of significant ways, which are as follows:
- Finding and fixing delays, inefficiencies, and mistakes in financial operations before they turn into problems.
- Using predictive analytics to foresee changes in market conditions, supply chain disruptions, etc. and create necessary contingency plans.
- Utilizing data-driven insights to guide organization-wide business procedures and strategically sound investments.
- Reducing the threat of financial fraud by improving data security and spend management.
Improve Supplier Relationship Management
When companies utilize financial analytics to control their spending, developing a good reputation with suppliers and benefitting from exclusive incentives like early payment discounts becomes easier. For example, tracking vendor payment error rates can assist companies in making appropriate payments at appropriate times for a healthy cash flow along with maintaining goodwill with their suppliers.
Shortcomings of Financial Statements
There are a few shortcomings associated with financial statements. Some of the shortcomings are:
- Financial statements may be subject to fraudulent manipulation, fooling investors into thinking the issuing entity has achieved better results than it actually has.
- Lenders may offer debt to companies that may not be able to repay it realistically, as a result of such manipulation.
- Financial statements are solely historical in nature, they can be deceptive when used to forecast a company’s future performance.
- Such statements do not cover any non-financial issues. There are various non-financial factors which affect the position of the company. Hence, such statements do not provide the final picture of the entity.
- Financial statements are recorded at historical costs. The real value of assets and investments changes according to the current price. Therefore, financial statements do not provide the real scenario.
- Such statements ignore the effects and impacts of inflation on the assets and liabilities. Under this, the financial statements may mislead.
- There are multiple accounting practices and accounting policies. Comparison of two different companies or comparison of same company in two different time periods is only possible when the same accounting practices or accounting policies are followed.
- Financial statements highly focus on quantitative parameters and thus miss out the qualitative information which can be crucial for analyzing an entity.