Objectives of Financial Statements

The primary objective of the financial statement is to provide financial information about the company. It can help the stakeholders and other users make economic decisions, including past performance and current position assessment, predict and judge the company's growth and predict its situation of bankruptcy or any failure.

#1 - Past Performance and Current Position Assessment

The primary objective is to depict past performance. This is because the organization's future performance is dependent on past performance. On the other hand, the other represents the current position where the business stands in the present scenario. For example, it may show the types of assets owned by a business and the li­abilities due to a business entity.

It also explains the cash position and the mix of debt and equity available to the organization.

Practical Application

An investor or creditor is always keenly interested in the trend of sales, net income, expenses, cash flow, and the organization's return on investment. These trends are beneficial for judging management's past performance and thus serve as possible indicators of the entity's future performance. Assessment of Past Performance and Current Position is very crucial for financial transparency required by various decision-makers.

#2 - Prediction of Net Income and Judging the Growth

The objective of the financial statement lies in predicting the earning prospects of net income and judging the business's growth.

• The financial statement helps in planning and forecasting. Financial statements help the management adopt an appropriate business policy by requiring comparisons among various peer organizations. It helps in forecasting and preparing budgets by providing information regarding the strengths and weaknesses of the business.
• Thus the importance of financial statements to management is that it helps communicate with different parties about their financial position. The CFO refers to financial reports to make dividend-related decisions. He would look at the profits made, the debts to be paid off, the provisions made for reserves, and decide the dividend to be distributed.

Practical Application

A growth trend can be concluded by comparing data from two or more years of business entity. For example, if there is an increase in sales with increased profits, it can be concluded that the business state is healthy.

While comparing investment alternatives, investors are considerate of the risk or uncertainty associated with the business's expected return.

#3 - Prediction of the Bankruptcy of a Business Entity and another Failure

It helps keep track of the solvency of the business. It helps in predicting the bankruptcy and failure probability of business enterprises. The capacity of the entity to repay its short and long term liabilities must always be known.

Practical Application

Both managers and investors can take preventive measures to avoid or minimize losses to maintain solvency.  For example, corporate management can bring changes in operating policy, financial structure, or other required changes that can be incorporated.

#4 - Help Stakeholders and other users to make Economic Decisions

It provides essential information required by stakeholders to take various economic decisions like the one about the financial position of the enterprise.

• Like banks and other lending companies, financial institutions use it to make loan decisions or other credit decisions. It helps to decide whether to grant working capital, extend debts such as long-term loans or debentures to finance expansion, and other expenditures or not. If yes, a financial statement helps determine the credit risk associated, deciding terms for the lending and conditions of loan like collateral, interest rate, and maturity date. Thus, creditors use financial reports widely to assess the creditworthiness of the organization.
• Prospective investors use financial reports to assess the viability of investing in a business. Financial analysis is often used by investors and is prepared by professionals like financial analysts. Thus the importance of the financial statement is that it helps them make investment decisions.

Financial statements are a critical factor in ensuring that the actual financial picture of the business is presented to management and external stakeholders. It opens a window for known and educated decision-making and strategic planning for stakeholders. Still, financial statements also aim to mitigate errors that may arise due to discrepancies in numbers in various financial statements.

Understanding the basic financial statements is a necessary step toward successfully managing an enterprise.

Also, accurate financial statements induce trust in the company. Therefore, building trust is also a very crucial objective of financial statements.

This article is a guide to the Objectives of Financial Statements. Here we provide the list of top 4 objectives, including performance assessment, forecasting, bankruptcy predictions, etc. You can learn more about accounting from the following articles –

• 5 Limitations for Analysis of Financial Statement
• Credit Risk Formula
• Types of Financial Analysis
• Components of Financial Statements