Top 4 Purposes of Financial Statements: Why are They Required

Purposes of Financial Statements:

The main purpose of financial statements is to provide information about an entity, including, but not limited to, Financial Performance, Financial Position, Profit or Loss, Nature of Business, Assets, Liabilities, and Equity

Such information is very important for users to assess the entity’s status to support their decision-making. 

Before explaining the common purpose of a Financial Statement, we would like to mention three elements of financial statements. They are Statement of Financial Position, Income Statement, and Statement of Cash Flow.

You may be interested in checking here => Three elements of financial statements.

The Financial Statements contain much important information about the entity in terms of financial perspective. That information included:

The clip below also explain you some about the purpose of using Financial Statements.

1) Assets

purposes of financial Statements
purposes of Financial Statements
  • Property Plant and Equipment
  • Inventories
  • Receivables
  • Cash and Other cash equivalence
  • Others Assets

2) Liabilities

  • Accrual
  • Salaries Payable
  • Account Payable
  • Long-term and short-term debt
  • Others Liabilities

3) Equity

  • Ordinary Shares
  • Shared Values
  • Retain Earning

4) Income

  • The main income of the entity ( Sales of Goods or Services)
  • Other sources of incomes

5) Expenses

  • Cost of Goods Sold
  • Operating expenses listed by components
  • Others expenses

The above is important financial information for the entity from a financial perspective. Different people or groups could use that information for different purposes.

Here are the four general purposes of financial statements we mention above.

To help Owners and Managers of the Entities.

This is probably the first Purpose of Financial Statements. Why is it important for the owner and manager? Well, their purpose is not different from others.

Financial Statements are quite important for this group of people. The statement provides all information related to the financial perspective of the entity; therefore, the owner and management could use that information for performance evaluations and appraisals.

Financial Statements analysis techniques are used to figure out those performances. The statements could be reported on a specific period; for example, quarterly or annually.

To help Entities’ Employees.

Another Purpose of Financial Statements is to help the employee. Why are financial statements quite important for employees?

Well, there are many purposes, but the most important is to analyze whether the entity could sustainably make the payment on their salary and identify whether the entity could secure their job.

To help Prospective Investors.

Well, this is quite common. The entity’s prospective investors or future shareholders, especially in the financial market, always use the entity’s financial statements to evaluate the financial viability and return on investment acceptability.

Investors also use the statement to assess the stability of the entity for future growth. This could be done through the financial statements analysis technique.

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To help Financial Institutions.

Not only shareholders and return on investments are the important source of finance for the entity, but Financial Institutions are also major sources.

The entity normally borrows loans from financial institutions to support its operations or projects. Those Financial Institutions include banks and other lending companies.

Before providing loans, those companies, if loans are large enough, obtain the financial statements of the companies and the purpose to assess whether the borrowing company could repay its loan principal as well as interest.

In most cases, profitability, cash flow, and secure assets are the main factor that they always review and assess.

In most cases, profitability, cash flow, and secure assets are the main factor that they always review and assess.

List the top 10 Purposes of the Balance Sheet.

A balance sheet is an important financial statement that reports a company’s assets (what it owns), liabilities (what it owes), and equity (the difference between assets and liabilities) at a specific point in time.

Here are the top 10 purposes of a balance sheet:

1. Provide information on financial position: A balance sheet can provide useful information to help assess the financial health of a company, such as its current liquidity, debt load, and net worth.

2. Track progress over time: A balance sheet can be used to track progress by comparing changes in asset values, liabilities, and equity from one period to another.

3. Determine cash flow: The balance sheet helps determine how much cash is available for operations by subtracting total liabilities from total assets.

4. Calculate ratios: Balance sheets can be used to calculate various business metrics such as working capital ratio, debt-to-equity ratio, return on asset (ROA), etc.

5. Identify trends: By carefully analyzing each line item on the balance sheet over several reporting periods, you may notice certain trends which could indicate areas of concern or potential growth opportunities in the future.

6. Assess solvency: A balance sheet provides useful information to evaluate whether a company is a solvent or not—that is, if it has enough assets to cover all its debts and obligations in the future without raising additional funds through financing or using up extra resources like liquid cash or inventory items.

7. Analyze liquidity: Liquidity ratios measure a company’s ability to pay short-term obligations when they come due; this is important for the creditworthiness and overall financial health of companies and is measured using measures such as current ratio and quick ratio, which are derived from the numbers on a firm’s balance sheet report.

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8. Make decisions about investments: Investors use the information found on a company’s balance sheet from quarter to quarter or year to year to assess how their investment might perform over time – either positively or negatively – based on what kinds of assets/liabilities the company has reported recently.

9. Meet regulatory requirements: Companies must prepare and deliver regular documents like quarterly or yearly reports that include their most up-to-date balance sheets; these documents must meet certain regulatory requirements set forth by various organizations like SEC for companies to remain compliant with governance laws.

10. Justify loan applications: The banks look at past performance, current assets/liabilities position, potential growth prospects, etc., before deciding whether or not to approve any loan application; these factors are usually reflected in the numbers reported on an updated annual/quarterly basis in the form of a strong/weak balance sheet report.

Top 7 Purposes of Income Statement

1. To report a company’s financial performance over a period of time: The income statement provides information about a company’s revenue, expenses, gains, and losses during an accounting period.

2. To provide insight into a company’s cash flow: An income statement can be used to analyze the changes in a company’s cash flows over the accounting period.

3. To assess profitability: By looking at the income statement, one can evaluate how profitably a company is operating by comparing its revenues with its expenses.

4. To compare financial performance between periods: An income statement can be used to compare the same business operation across two or more different periods, such as quarters or years. This comparison enables a business to measure its performance against its historical trends and competitors.

5. To evaluate management efficiency: The income statement can identify areas where expenses are higher than expected and provide insight into potential problems with management efficiency or operations processes that may require improvement over time.

6. To make decisions on future activities: In combination with other statements, such as the balance sheet or cash flow statements, an income statement can be used to make decisions about future activities that will affect the business’s bottom line.

7. To satisfy regulatory requirements: Companies must report their financial performance annually for tax purposes and by specific regulations set forth by government agencies such as the Securities and Exchange Commission (SEC).

Top 8 Purposes of Statement of Cashflow:

1. To provide an indication of the changes in a company’s financial position over time.

2. To understand the sources and uses of cash during a period.

3. To assess the liquidity and solvency status of the company.

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4. To gain insight into the effectiveness of the firm’s management in generating returns from its assets and liabilities.

5. To assist creditors in evaluating their risk when making decisions about granting credit to a company and determining whether it can pay its debts as they become due.

6. To enable users to ascertain whether financing activities are sufficient to support ongoing operations and investment activities or whether external financing is required from lenders or investors.

7. To assist potential investors in understanding how effectively cash has been converted into profit and assessing cash flows related to proposed investments or mergers/acquisitions.

8. To serve as a basis for predicting future cash flows through analysis and interpretation over multiple periods that provide insight into forecasting future performance trends.

Top 10 Purposes of Statement of Change in Equity

1. To show the effects of transactions between the shareholders and the corporation, such as dividends paid or shares issued.

2. To record any changes in ownership due to stock splits, reverse stock splits, transfers of shareholdings, and mergers and acquisitions.

3. To adjust shareholders’ equity accounts for non-cash items, such as adjustments for unrealized gains and losses on available-for-sale securities.

4. To reflect changes due to the exercise of stock options or warrants by employees or other parties.

5. To explain any changes in retained earnings from one period to another due to net income or losses realized during that period.

6. To identify any transfers from retained earnings to other components of shareholders’ equity as part of a company’s cash flow plan for financing projects, such as plant expansion.

7. To report changes resulting from reductions in stated capital through repurchases of treasury stock or reclassifications between authorized capital items like common and preferred shares that affect a firm’s ownership structure without changing its total number of outstanding shares.

8. To report any distributions made directly to the individual shareholders rather than through their brokerage accounts (i.e., dividend payments).

9. To provide investors with a historical record showing how corporate actions have altered their investments since they acquired them (elderly records).

10 To enable a comparison with statements presented in previous periods so that investors can assess how well their investments are doing relative to previous years.

Conclusion:

We might exclude many other Purposes of Financial Statements from the list above. However, we believe that what we list above is the most important:

  • To help Owners and Managers of the Entities.
  • To help Entities’ Employees
  • To help Prospective Investors
  • To help Financial Institutions