Purpose of Financial Statements
Financial statements provide a summary of a company’s financial performance over a specific period. They are used by a variety of stakeholders to understand the financial health of a company. Here are the primary purposes of financial statements:
- Provide Information: The most basic purpose of financial statements is to provide stakeholders with accurate and reliable information about the company’s financial performance and position. This includes information about its revenue, expenses, assets, liabilities, and cash flows.
- Aid Decision Making : Investors, creditors, and management use financial statements to make important decisions. For example, investors might use financial statements to decide whether to buy or sell shares in a company, while creditors might use them to decide whether to extend credit to the company.
- Evaluate Performance: Financial statements allow stakeholders to evaluate a company’s financial performance over time and in comparison to other companies. This could involve analyzing trends in revenue and profit, or comparing the company’s performance to industry benchmarks.
- Assess Financial Stability: Financial statements provide insights into a company’s financial stability and liquidity. This helps stakeholders understand whether the company is likely to be able to continue operating in the future.
- Regulatory Compliance: Companies are often required by law or by the terms of their debt agreements to produce regular financial statements. These statements must typically be prepared in accordance with standardized accounting principles to ensure their accuracy and comparability.
- Tax Calculations: Financial statements provide the basis for calculating a company’s tax obligations. The revenue, expenses, and profits reported in these statements are used by tax authorities to determine how much tax the company owes.
In summary, financial statements are a key tool for providing stakeholders with important information, aiding decision-making, evaluating performance, assessing financial stability, ensuring regulatory compliance, and calculating tax obligations.
Example of the Purpose of Financial Statements
Let’s consider an example using a hypothetical publicly-traded company, “Healthy Snacks Inc.”
- Provide Information : Healthy Snacks Inc. publishes its quarterly and annual financial statements, providing essential data about its revenues, expenses, assets, liabilities, and cash flows. This gives stakeholders a clear picture of the company’s financial health.
- Aid Decision Making: An investor is considering purchasing shares of Healthy Snacks Inc. They review the company’s financial statements to understand its profitability, growth, and financial stability. They see strong revenue growth and healthy profit margins, leading them to decide to invest in the company.
- Evaluate Performance: A market analyst is writing a report comparing Healthy Snacks Inc. to its competitors. By reviewing the financial statements of Healthy Snacks and its competitors, the analyst can compare profitability, efficiency, liquidity, and other key performance indicators.
- Assess Financial Stability: A bank is considering whether to grant Healthy Snacks Inc. a loan for expanding its production. The bank reviews the company’s balance sheet and cash flow statement to evaluate its ability to repay the loan. Seeing that the company has low debt levels and strong cash flows, the bank decides to approve the loan.
- Regulatory Compliance: As a publicly-traded company, Healthy Snacks Inc. is required by the Securities and Exchange Commission (SEC) to provide regular financial statements. This ensures that the company remains transparent to its shareholders and other stakeholders.
- Tax Calculations: The Internal Revenue Service (IRS) uses the financial statements of Healthy Snacks Inc. to calculate the company’s corporate tax liability. The net income figure, in particular, is a crucial determinant of the company’s tax obligations.
In this example, you can see how financial statements provide critical information to various stakeholders and play a central role in decision-making, performance evaluation, financial stability assessment, regulatory compliance, and tax calculation.
