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Definition of Financial Statements.

Updated on April 3, 2013


Financial Statements or reports are account balances arranged in effective and meaningful.order so that the facts and concepts they portray may be readily interpreted and used as bases for decisions by all those interested in the affairs of business concern. Management on the basis of information given by these reports. may review the company''s progress to date and decide upon in the course of action to be taken in future: creditors may choose to extend or maintain or restrict credit.Share holders may judge prospects for their investment. and elect to sell or continue the ownership labourers may judge the ability of the company to pay more wages and the customers may appraise the effectiveness of the economic unit from which they buy goods or services

The term 'financial statement' refers or two statements- the Balance sheets or statements of financial position reflecting the assets. liabilities and capital on a particular data and income statement or profit and loss Account. showing the operational results during a certain period. Usually they are prepared at the end of given period for a business concern in the case of limited companies there include Profit and Loss Appropriation Account. In big companies the have a third statements which is called '.package of financial statements and it includes relating to land, buildings, equipment, inventories long term investment, accrued liabilities. long term debt, cost of goods manufactured, selling expenses etc. these schedules constitute the first towards the analysis of certain data in the Balance sheet and income statement.when adequate information cannot be given merely by listing of financial statement items.explanatory footnotes are to be given as an integral part of financial statements.


Nature of Financial Statements

Financial statements are plain statements of informed opinion uncompromising in their truthfulness. It is meant that within the limits of accepted accounting principles and of the very human abilities of the persons preparing them they are to rely on' judgements and estimates divorced of fancy and prejudice. .'

Recorded facts represent the data contained in the statements as found in accountingrecord,s and they consist of such data as cash on hand and in the bank, the amount due from customers, the cost of fixed assets, the amount due to creditors etc. As the price level (cost) of fixed assets on the date of acquisition is stated as a rule in the accounts rather thanthe replacement cost, the balance sheet does not show the financial position of a business in terms of current economic conditions. Of course in some cases, appraised values might be substituted for cost. Certain factors, which affect the financial position of a business, appear as footnotes to the Balance sheet. Generally they are unexecuted orders, purchases and salecontract and commitments, claims for tax refunds, judgments, endorsements and guarantees.

Advantages of Financial Statements.

The financial statements show the financial position and operating strength or weakness of the company. They are the basis for taxation, price regulation, granting of credit by banks etc. They are useful to management, creditors, bankers, investors, government, trade associations and stock exchange.

Their uses to the various parties are as follows:

1. Management: The efficiency of different cost centres are assessed by thesestatements. The efficient and inefficient spots are brought to the knowledge of themanagement. The management is able to exercise cost control and decide thecourse of action to be followed in future.

2. Creditors: They are interested in the short term solvency position of the company.Hence they are a7b-leto calculate the current and liquid ratios through thesestatements.

3. Bankers: They want to as1e the financial strength of the concern before theygrant any credit. It is through these statements, that a banker can study thefinancial health of the company They can also watch the performance of theircustomers.

4. Investors: The investors are interested in the security of the principal amount anda regular return from the company. Hence they will study the long-term solvency position of the concern with the help of financial statements.

5. Government: These statements enable the government to find out whetherbusiness is following various rules and regulations or not. These statements arealso used to assess the tax liability of the concern.

6. Trade Association: They may analyse these statements for the purpose of proyidingfacilities and services to their members.

7. Stock Exchanges: They deal in purchase and sale of securities of variouscompanies. The financial statements help the stock brokers to judge the financial position-of companies. The fixation of prices for securities is also based on these statements.

Limitations of Financial Statements

1. Financial Statements are essentially interim reports and hence, cannot be finalbecause the actual gain or loss of a business can be determined only after it hasput down it shutters.

2. They tend to give an appearance of finality and accuracy, because. they areexpressed in exact money amount. Any value of the amounts presented in the
statement depends upon the value standards of the person dealing with them.

3. The Balance Sheet loses its function as an index of current economic realities due to the fact that financial statements are compiled on the basis of historical costs, while there is a marked decline in the value of the monetary unit and the resultant rise in prices. The problem has become more important especially during the war and the post war period.

4. They do not give effect to many factors which have a bearing on financial conditionsand operating results because they cannot be stated in terms of money and are qualitative in nature. Such factors are the reputation and prestige of the business with the public, its credit rating the efficiency and loyalty of its employees and integrity of management. Due to these limitations it is said that financial statements do not show the financial condition of a business, rather they show the position of financial accounting for a business.


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