Financial Statements Are Formal Records That Provide All The Relevant Financial Information Accounting Essay


Financial statements are formal records that provide all the relevant financial information of individuals, organizations or a business. In addition financial statements are also formally a part of financial reporting which quantitatively defines the financial health of an organization or business. There are two main aspects to financial statements: first describes the financial health of an entity; for example business, an organization etc. Second shows how the entity has performed financially over an accounting period. Thus, financial statements can be used for historical or for future reference. A financial statement generally includes a balance sheet, an income statement, a cash flow statement, statement of owner's equity and notes and schedules which are fundamental part of financial statements. However, it does not include reports by directors, chairman's speech and analysis by management which is included in an annual report.

The financial statement balance sheet shows the health of a business as of a specific period and it is generally dated on last day of the reporting period. A standard balance sheet has three parts namely; assets, liabilities and ownership equities. The difference between the asset and the liability is known as the net worth of the company. The income statement shows the income and expense of a business for a specific time period. The main goal of income statement is income less expense. In addition, a business makes profits when its income is more than the expenses and it suffers losses when the expenses exceed income. An income statement helps different users like creditors and investors to determine past financial position, future performance, and to assess the capability to generate future cash flows. The statement of cash flows shows the inflow and outflow of cash during the reported period. The money coming into business is called cash inflow and money going out from business is called cash outflow. Further, the cash flow statement is divided into three parts, namely: cash flow from operating activities, investing activities and financing activities. All the statements are part of financial reporting which results in accounting information.

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Financial accounting aims to provide financial information to stakeholders outside the organization and helps the stakeholders in decision making. Moreover, in the business environment it reduces the uncertainty where the decisions are made for the future. It gives the management a clear picture about the organization and on the basis of that information the management can estimate the budgets for the future. The main aim of such information is that it should be useful to different users.

The users of financial information can be divided into two main categories, namely internal and external users. The internal users have the right to direct and unlimited access to all the organization's information at any point of time. This financial information helps management in decision making process within the separate departments. For example, Human Resource manager has the right to use the employee's wage information along with other data. In contrast, the external users of financial information have limited and indirect right to access all the organization's information which are contained in the financial reports and reported by the media. Typically, government and regulatory agencies have the right to get reports in specific form. Moreover, internal users can obtain financial information on regular basis, i.e. monthly, weekly or daily, but external users have to wait for annual and interim reports and other source of financial information such as press releases to get published or announced.

Internal users have the right to get detailed information, whereas external users have no right for detailed information and they only get aggregated information which are contained in the financial statements like balance sheet, income statements, and cash flow statements. Internal users use the financial information to run the organization or to make administrative, operational or strategic decisions. Whereas, external users use financial information to invest, supply materials or advance funding. The internal users of financial information include managers, internal auditors, sales staff, budget officers, controllers' staff and directors who require information for strategic, operational and administrative decisions. Whereas, the external users which include investors, lenders, suppliers, customers, government and the public who require the financial information for various purposes.

One of the primary users of financial information is investors. Investors use the financial statements to reveal the current profitability of the firm and make attempts to forecast its future profitability. The potential growth of a company's share price and also the likelihood of the company paying dividends to its share holders are the two core aspects that an investor will look for when making an investment. Financial statements shed light on the aforementioned aspects and it is this information that enables the potential investors to take rational investments decisions. Investors use financial reporting information of the past to help in assessing the future of an enterprise. When an investor makes an informed decision after interpreting the available information it is because the investor has some expectations for future enterprise performance and those expectation are mainly based on past enterprise performance. Financial information divulges the earning and spending pattern of an enterprise, about its long term and short term borrowing and repayments of borrowings, about its assets and liabilities, about its capital transactions and other miscellaneous factors that could have an effect on an enterprise's liquidity or solvency. Capital transactions are cash dividends and other disbursements of an enterprise's resource to share holders and to its employees. Although financial statements provide valuable information to investors it does have its limitations.

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On the basis of past or previous performance the investors estimate future performance of the company. Having said that, the future remains unpredictable and so are the uncertainties that come with it and thus there is no guarantee that a company would perform as expected. Further, an enterprise discloses its financial statements once yearly, half yearly or quarterly and there is a time lapse between each. In this time lapse, the company could do some major changes in their finance and in decision making process which is not made public until the next disclosure. Thus the basis on which an investor makes a decision is the financial statement of a company unless the company does not make any non- obligatory updates during such lapse period.

Next user of financial statements is creditors that include suppliers, banks and other lending institutions that provide loans and capital for a company's operations. Suppliers generally provide products, parts or raw-materials on credit and bank gives loans on interest for a company's operation. As a result suppliers and other creditors are interested in financial information because it enables them to determine whether the debt owed to them will be paid or not when it due. Moreover, creditors are also interested in the current and future cash flows of a company because cash flow helps creditors to determine the company's ability to generate cash from their ongoing activities. Creditors mainly place emphasis on liquidity and cash flow of a company as for creditworthiness.

Employees are another user of financial statements and they are considered as both external and internal users of financial reporting. Employees need financial information to check the stability and profitability of its employer. Moreover, employees are looking for job security and the return of a job they do. Therefore, employees are looking for results in the financial information so that they can assess if the company is doing well enough to continue to employ them or not. In addition, the employees will be interested in the company's performance if the company provides good remuneration, retirement benefits and employments opportunities to them on a regular basis.

The final set of users of a company's financial information is the general public, which tries to assess a company's effects on the local community, such as job opportunities, its general economy, taxes, environment and the contribution towards the charitable institution. Thus, it is a requisite for the general public to constantly analyze the financial information in order to monitor the contribution of an organization towards its society.

In conclusion different users need different financial information for decision making. These needs are changing constantly in response to a changing environment. This means that accounting information is flexible enough that it adapts different demands for different users. Companies provide different financial information to different users in the form of various financial statements, press releases etc. Financial information data is generally used by various users for the creditworthiness, to check companies operation, borrowing and repayment of borrowings etc. However, financial information statements provide useful information to different users but they have some limitation that the users have to consider. During the decision making process users must consider all the financial statements at once and not just individually because an individual statement does not paint the complete picture of a business or an organization. For instance, the income statement alone is incomplete and has no significance unless it is coupled with a balance sheet or the cash flow statement.

A, Ward (2003) The need and uses of financial information [Online] Available at: (Accessed: 6 November 2010).

J, Cote (2005) 'Creditors ' Use Of Operating Cash Flow: An Experimental Study*' All Business [Online]. Available at: (Accessed: 5 November 2010).

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What is the purpose and natures of financial statements and managerial reports? (no date) What is the purpose and natures of financial statements and managerial reports? Available at: .com/question/index?qid=20070722111952AApFJ0v (Accessed: 12 November 2010).

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Who are the key users of accounting information? (no date) Who are the key users of accounting information? Available at: accounting information (Accessed : 10 November 2010).