Importance of Financial Statements

Financial Statements are very important as they accurately reflect the company's business performance and financial position. Additionally, it helps all stakeholders, including management, investors,  financial analysts, etc., evaluate and make suitable economic decisions by comparing past and current performance and, therefore, predict future performance and growth of the company.

Every business must prepare its financial statements in a clear and transparent manner so that it can be referred to while studying the business performance. It should also be audited and scrutinized for any discrepancy so that stakeholders and management can have clarity regarding where the company stands in the market. It is a window through which the entire company performance can be viewed for information related to past, present and future.

The importance of financial statements in the corporate sector and financial market cannot be denied in any way. The financial statements include the income statement, balance sheet, cash flow statement and statement of equity. Each of them has its own role to play in the market, where shareholders, lenders, management and analyst continuously refer to them for information related to the past current and future performance of the business.

The importance of financial statements analysis lies in the fact that no decision can be confidently taken without referring to these statements and the data contained in them because they show all relevant financial information like the revenue, cost, profits, cash flows, expenses, asset and liability position, etc. From these data, it is possible to derive a conclusion regarding whether the company is profitable and sustainable, whether it is burdened with huge debt and lacks liquidity and creditworthiness, its future investment plans and possible funds allotted for them, and so on.

Such information not only directly influences the stock prices and valuation but also provides confidence to investors and lenders that it is worth investing in this company. It provides assurance that the money will generate the expected return and the business has good growth prospects in the future.

The importance of financial statements in business is always necessary for every stakeholder and they need to refer to these statements thoroughly and study them so that they are informed about the company's performance before they make any investment decision. Since these statements are readily available in the public domain, it is easy to understand and use them.

In this article, we provide the list of top 10 important financial statements –

#1 Importance of the Balance Sheet

The balance sheet shows the company's financial position and provides detailed investments of the company's asset investments. The balance sheet also contains the company's debt and equity levels. This capital mix helps investors and creditors understand the position and the company's performance.

There are differences in reporting various items in IFRS and US GAAP. For example, long-lived assets, inventory, intangible assets, leases, impairment of long lived assets as well as taxes

#2 Importance of Income Statement

The balance sheet is a snapshot of the company's assets, liabilities, equity, and debt. It does not show what happened in the period that caused the company to get to the position where it is now. Therefore, profit figures on the income statement are important to the investors.

Income statement format contains sales, expenses, losses, and profit. Using these statements can help investors evaluate the company's past performance and determine future cash flows.

IFRS and US GAAP also differ in the classification of certain expenses like restructuring charges, shipping costs, and handling costs. The necessary expense of depreciation and discontinued operations are also treated very differently.

#3 Importance of Cash Flow Statement

To study the importance of financial statements analysis it is necessary to understand that the Cash flow statement shows the inflow and the outflow of the cash flow in and out of business during the financial period. It gives the investors an idea that the company has enough funds to pay for its expenses and purchases.

The cash flow statement has all three main headings, i.e., Operating, Investing, and Financing. It gives the business an overview of the entire business.

Under the US GAAP, interest received and paid will be a part of operating activities, while under IFRS, interest received will be a part of operating or investing activities. Interest paid will be a part of operating or financing activities. Similarly, under US GAAP dividends received will be a part of operating activities while dividends paid will be a part of financing activities, and under IFRS, dividends received will be a part of operating activities while dividends paid will be a part of the financing.

#4 Importance of the Statement of Equity

It is primarily important to the equity shareholders because it shows the changes in the components like retained earnings during the period. The difference between equity and debt shows the companies net worth.

A company with a steady increase in retained earnings is sustainable as opposed to increasing shareholder base.

#5 To the Management

The complexities and the size of the business make it necessary for the management to have up-to-date, accurate, and detailed information about the business and its financial position. The financial position helps the management understand the company's performance in comparison to the other businesses and the sector.

Providing management with accurate information enables them to form proper policies for the companies and make correct decisions.

These statements rank the performance of management. The performance of these statements will help management justify their work to all the parties involved in the business.

#6 To the Shareholders

The importance of financial statements to users like the shareholders are due to the fact that they are they are the business owners but do not take part in making decisions and day-to-day activities. However, these results are shared with the shareholders at the AGM held annually.

These statements enable the shareholders to understand how the company has been performing. It also allows them to judge the present and future performance

Financial statements are the most important source of information for current and prospective customers. They also need it to understand the dividend payout ratio and forecast the future dividends

#7 To the Creditors and the Lenders

Factors like liquidity, debt, and profitability are all judged by the essential metrics in the financial statements. Creditors and Lenders are most concerned about the company's debt position. If the debt level is higher than the other companies in the same industry, it means that the company is over-leveraged

Analyzing these statements will help them decide if they want to continue and determine their future course of action.

#8 To the Employees

The importance of financial statements to users arise because some companies present different financial statements for their employees. Employees need business information for mainly two reasons: their current wage and future salary appraisals. They will be interested in knowing the current condition as well as the future earnings

#9 To the Government

Another importance of financial statements is that the government uses financial statements for taxation purposes. The government uses the business performance of these companies in various sectors to assess the economies' performance.

#10 To the Company

Debt Management

Debt can cripple the progress of any company, no matter which sector the company belongs to. Ratios like debt to equity, interest coverage ratio, debt service charge, etc., help the management make important decisions related to debt lead to the importance of financial statements in business.

Trend Analysis

Trend analysis of the future metrics and identify the trend of both past and present. It will help the business understand the company's current weakness and overall health.

Tracking

By getting accurate and regular information, decisions can be made quickly and swiftly. It helps in avoiding roadblocks and maintaining financial liquidity at the same time.

Liability Management

If the company wishes to borrow any money, it can look at the current liabilities by using the financial statements. Business loans and credit cards are liabilities that the company must consider before applying for other loans.

Compliance

All public companies must publish financial statements quarterly or annually. Hence to also be compliant with the government norms, it is necessary to publish these statements.

There are also differences in the balance sheet and income statement layout. There is no specific requirement for balance sheets and income statements; however, public companies must follow the particular guidelines as per the regulation by the SEC. In the case of IFRS, there is no prescribed layout but has a limitation on the number of line items.

This has been a guide to what is Importance Of Financial Statements. We explain the importance of each type of statements & analysis. You can learn more about accounting from the following articles –

• Financial Statements Components
• Pro Forma Financial Statements
• Interim Financial Statements
• Audited Financial Statements Objectives