The Importance Of Accurate Financial Statements

The role of financial accounting is not to show the value of a company, but rather it provides enough information for others outside the company to determine the value of the company for themselves.

Financial Statements according to Oxford Online Dictionary are annual statements summarizing a company’s activity over the last year. They consist of   the profit and loss account, balance sheet,   statement of total recognized gains and losses   and, if required, the cash flow statement   together with supporting notes.   Proper financial statements are crucial for a company’s success. Bad financial management can quickly lead to a company’s downfall. Income statements, also known as P&L’s or profit and losses are a basic account of the company’s profits, expenses and sales. These reports will give insight into the finances of a company in the immediate and distant future.  

Balance sheets are the assets, liabilities and the equity of a company. This sheet is simply the statement of a company’s financial position. The balance sheet does not apply to the future only to the present point in time. Retained earnings statements are forms that show the balance of initial earnings, any changes that took place and the resulting balance of that.   Lastly, when discussing financial statements comes’ the cash flow statement. This is basically a statement that contains information about a company’s cash flow for the short term. This statement will break down all investing, financial and operations activity.   Company’s use all of these statements to determine current financial profitability and potential future growth.

Without accurate financial statements, and owners and managers ability to correctly understand them, any company is fated to failure. A company could track previous growth and then make an estimate on possible future growth of the company.   Liabilities are any debts, claims, obligations or potential losses a company may have. An example of a liability is an account payable. Accounts payable is simply money that a company owes but has yet to pay. This could be tracked to help reduce future expenses that have ended up costing more than they should have.

Businesses have two primary objectives: to remain solvent and to earn a profit.   A company’s solvency is the ability of the business to pay its bills and service its debt. The better their solvency, the better they are financially. This is different from a company being profitable.   There are four financial reports that show business owners their profitability: the Balance Sheet, the Income Statement, the Statement of Owner’s Equity, and the Statement of Cash Flows.   These reports are also the financial product of an accountant’s analysis of the transactions of the business. A lot of effort goes into preparing these financial statements.  

The Balance Sheet shows a particular point in time.   It highlights what resources are owned by a business and what it owes to other parties.   It also shows how much has been invested in the business and what the sources of that investment were.   The balance sheet is often referred to as the “snap shot” of the business, or a picture of the financial position at that specific point.  

In contrast, the Income Statement, also known as the profit and loss statement, provides a perspective on a longer time period. If the balance sheet is a snap shot, think of an income statement like a photo album of the business activities. That photo album is like a story of what financial transactions took place in a particular time frame, and what the overall results of the transactions actually were.

The Statement of Cash Flows explains the change in the company’s cash during the time interval indicated in the heading of the statement. “It is meant to help managers and investors understand the relationship of net income to change in cash balances.”(Holmgren, Sundem, Elliott, Philbrick, 2006, pg.185) This report is split into three sections: Operating activities, which explains how a company’s cash has changed due to operations; investing activities, refers to amounts spent or received in transactions involving long-term assets; and financing activity, which shows such things as cash received from long term debt, or most commonly through the issuance of stock.

All of this reporting shows company information.   It explains where a company’s money came from, where it is now, and where it is going, but the root of it all begins with bookkeeping. Basic bookkeeping monitors what the company’s check book looks like and what their reoccurring expenses are like payroll, rent, along with any other operating expenses. Every business needs some sort of process to track their expenses and their income without any analysis of their in-and-out flows.   This is where the accountants come in the picture. They evaluate and analyze the information making sense out of the numbers to explain the bigger picture.   For any of the above reports to be useful to an owner or investor, they need to be understandable, timely, relevant and free from bias.