A company's financial statements contain important financial information about it. The preparation and reporting of financial statements are governed by generally accepted accounting principles. Financial statements play an important role within business, providing key information to managers, investors and creditors. Primary functions of financial statements include financial reporting, financial analysis and cash flow management. Managers, investors and creditors must understand the functions of financial statements to use them in the most effective manner.
Key Financial Statements
The three key financial statements produced by most companies include the income statement, balance sheet and the cash flow statement. The income statement shows how much a company earns in revenue over a certain time period and the expenses related to the revenue earned. A balance sheet displays a company’s assets, liabilities and owner equity at a specific point in time. The cash flow statement shows how much cash is coming into a company and how much cash is flowing out of a company during a specific time period. Financial statements are connected to each other. For example, the changes in assets and liabilities shown on the balance sheet are connected to the change in revenue presented in the income statement.
One function of financial statements is financial reporting. Investors and creditors depend on the financial reporting of a company to make investment decisions. Financial reporting involves the preparation and distribution of formal financial records that show a company's financial activities. Financial statements help creditors and investors determine whether a company is effectively using the money invested in the firm. Publicly traded companies are required by the SEC to make their financial statements available to the public. Many private companies choose to make their financial statements available to their investors and creditors.
Financial Ratio Analysis
Another function of financial statements is financial ratio analysis. Financial statements contain important financial data that business owners and investors use to calculate key financial ratios. Financial ratio analysis allows investors to compare the current financial position of a company to its historical financial data and to the financial data of its competitors. A manager uses financial ratio analysis to make key decisions regarding its company. Financial ratio analysis indicates a company’s efficiency, liquidity, profitability, leverage and creditworthiness.
Maintaining an adequate amount of cash is an important aspect within business. The possibility exists for a company to experience a positive or negative cash flow. A primary function of financial statements is to show how effectively a company manages its cash inflows and outflows. A company that earns a profit but maintains an inadequate amount of cash may experience a difficult time attracting investors and lenders. The cash flow statement focuses primarily on a company's net cash flow. Managers must adapt effective cash management policies to maintain a positive cash flow.
- Deloitte: Presentation of Financial Statements
- Valencia College: The Importance of Financial Information
- The U.S. Securities and Exchange Commission: Beginners; Guide to Financial Statements
- Cliff Notes: Financial Reporting Objectives
- James Madison University: Financial Ratio Analysis
- FindLaw: Cash Management Basics
- Robert Fullet. "How to Keep Score in Business," Page 2. FT Press, 2012.
- Financial Accounting Standards Board. "Comparability in International Accounting Standards—A Brief History." Accessed Sept. 25, 2020.
- U.S. Securities and Exchange Commission. "Form 10-K." Accessed Sept. 24, 2020.