FINANCIAL STATEMENTS: ITS IMPORTANCE TO A BUSINESS ENTITY

FRESCY A. MOSTER

COLLEGE OF BUSINESS, NORTHEASTERN MINDANAO COLLEGES

FINMA 4: FINANCIAL ANALYSIS AND REPORTING

MR. LORENCE S. BUSELAK

OCTOBER 22, 2021

 ABSTRACT

Financial statements are prepared based on financial accounting data in accordance

with established forms for a certain reporting date. It follows from this definition that
the data reflected in the financial statements essentially represent a special type of
accounts that are extracted from the current accounting of the summary data on the
status and performance of a company for a certain period (Korableva et al., 2017b).

The main objective of this study aims to learn more about financial statements and to
determine their role in a business entity. And to analyze some of the minor objectives
which is to understand the types of financial statements used by different
organization, as well as their importance to the organization. The data used are
collected mainly from secondary sources. The findings says that three main elements
underline the importance of financial statements. First, as a communication tool for
delivering information to the accounting department for the activity and results of the
business. Second is to assess the overall performance of the business in terms of
efficiency and productivity. And lastly, to make financial decisions such as deciding
how to spend future resources, and guiding the future of the connections with the
institution, to make the best decisions possible.
 TABLE OF CONTENTS

TITLE PAGE................................................................................................................ i

ABSTRACT.................................................................................................................ii

INTRODUCTION........................................................................................................ 1

LITERATURE REVIEW..............................................................................................2

RESEARCH METHODS.............................................................................................3

FINDINGS...................................................................................................................4

DISCUSSION.............................................................................................................5

CONCLUSION............................................................................................................5

RECOMMENDATIONS...............................................................................................6

REFERENCES...........................................................................................................7
 1

INTRODUCTION

Financial statements are summaries of the operating, financing, and investment

activities of a business. Financial statements give investors and creditors information
that they can use to make credit, investment, and other business decisions. They
can use these statements to estimate, assess, and evaluate the amount, duration,
and uncertainty of potential cash flows. In other words, financial statements provide
the information needed to evaluate a company's profitability.

The main financial statements are the means used by the accounting for the purpose
of collecting, processing and presenting economic information. The purpose of
financial statements is to provide information on the position and financial changes
as a very important basis for making managerial decisions (Asllanaj, 2008). The
objective of the financial statements is to provide information about the financial
situation, financial performance and changes in an entity's financial position that are
usable by a wide range of users in making their economic decisions (Lewis, &
Pendrill, 2004). Financial statements reflect the cumulative effects of all of
management’s past decisions (Helfert, 2001). Financial statements are the business
documents that companies use to report the results of their activities to various user
groups, which can include managers, investors, creditors, and regulatory agencies.
In turn, these parties use the reported information to make a variety of decisions,
such as whether to invest in or loan money to the company (Charles, Walter &
Thomas, 2012). The main financial statements are International Accounting
Standards (IAS): Income statements, Balance Sheet, Cash Flow Statement, and
Statement of Equity Changes.

Financial statement preparations in a company are usually done by internal

accountants, who are directly influenced by the management of the company.
Companies make certain decisions based on information from financial statements.
Thus, a fraudulent or an erroneous financial statement implies a risk possibility which
can cause wrong investment decisions making in an organization. So, it is essential
to understand the significance of financial statements because they contain critical
information about the company's financial health. Additionally, financial statements
assists businesses in making informed decisions to generate the best return on
investment. This study therefore set out to assess the importance of financial
statements to the business entity.
 2

LITERATURE REVIEW

Financial Statements

To make well-informed decisions, a company’s management gleans data from

various sources amongst which are financial statements. Financial statements
therefore are a formal record of the financial activities of a business, person or other
entity. Another name for financial statements is also known as financial report.
Information on this report is presented in a structured manner and in a form easy to
understand. Given the importance of financial statement in investment decisions, a
lot of strategy goes into how a company must present its financial data and use such
information to win economic competition. Most often the goal of financial statements
is to steer the minds of the senior officers to combine their business knowledge to
find the best ways to drive the company towards profitability. Financial statement has
specific effects on investment decisions.

The financial statements of a company whose stock is publicly traded must, by law,
be audited at least annually by independent public accountants (i.e ., accountants
who are not employees of the firm). In such an audit, the accountants examine the
financial statements and the data from which these statements are prepared and
attest - through the published auditor's opinion - that these statements have been
prepared according to GAAP. The auditor's opinion focuses on whether the
statements conform to GAAP and that there is adequate disclosure of any material
change in accounting principles.

Types Of Financial Statements

There are four basic financial statements: the balance sheet, the income statement,
the statement of cash flows, and the statement of shareholders' equity.

The Balance Sheet

The balance sheet is a summary of a company's assets, liabilities, and equity at a

specific point in time, usually at the end of the fiscal year. The balance sheet is often
referred to as a statement statement of financial condition or a statement of financial
position. The values shown for the different accounts on the balance sheet are
not  intended to reflect current market values; rather, they reflect historical costs.

While the income statement is essential to understanding the business, it doesn’t

contain all the information needed for a thorough analysis. The balance sheet
provides the readers with data concerning the business debt loads and the value of
assets such as real estate. While a business’s revenue might be very healthy and
increasing, if its burdened with too much debt, or many outstanding invoices that its
clients haven’t paid, they may not be clear on the income statement. It will be
apparent on the balance sheet, however. Alternatively, a business with significant
real estate or other assets that aren’t monetized on the income statement will appear
here; for example, if the business owns its own building, land, or plant, these values
will be listed in the balance sheet. Thus, the balance sheet comprises of:

Assets: Refer to the thing owned by the business

Liabilities: Something the business owes it owners and represent the amount of
capital that remains in the business after the asset are sold to pay its outstanding
invoices. Thus, the difference between assets and liability equals equity.
 3

That is: Assets – liability = equity

The Income Statement

An income statement is a summary of a company's revenues and expenses over a

specific time period, usually either one month, three months, or a year. This
statement is also known as a profit and loss statement. It depicts the outcomes of the
firm's operational and financing decisions over that time period.

The income statement tells the reader how much money the company made from
and spent over a certain period, usually a month, quarter or a year. Subtracting the
total expense from total revenue reveals the business’s margin. Higher margins are
better because it means the business can spend less and keep a greater percentage
of revenue as profit. It is best to analyze income statement from several consecutive
years because it reveals what direction the business is heading to. As such with
income statement often asked:
Are margins growing smaller or larger?
Is revenue growing along with the expenses or are only expenses growing while the
revenues remain flat?
All these questions are answered by reading the income statements.

The Statement Of Cashflows

The Cash Flow Statement tracks the flow of cash through the business over time.
The Cash Flow Statement of a business is similar to a check register in that it records
all of the company's transactions that involve cash (checks) or supply cash
(deposits). The Cash Flow Statement demonstrates that cash on hand at the
beginning of a period plus cash received during the period minus cash spent during
the period equals cash on hand at the conclusion of the period.

This statement shows the flow of cash in and out of the business account. Actual
deposits and payment activity of account payable, payroll, revenue is reflected here.
A business that’s running low on cash but has adequate income and asset to fund
operation may have an account receivable problem or may need to refinance debts.

The Statement Of Shareholders' Equity

Finally, the last main financial statement is the statement of retained earnings also
known as the equity statement. It shows the movement in owners’ equity over a
period which is mostly determined from the company’s share capital issued; net profit
and loss as reported for the year. Most organizations will use the first two financial
statements to make investment decisions. Thus, it is only from reviewing the financial
statement that can they perform a reasonable investment decision.

RESEARCH METHODS

Secondary data were collected from various media is used in conducting this study. It
come from different sources, including websites, books, and journal papers. This
paper is essentially a secondary data analysis that uses the information obtained by
someone else. The researcher used secondary data to answer the new research
question and look at a different angle on a previous study's original question. Existing
data is summarized and collated to increase the overall effectiveness of the research.
 4

FINDINGS

The information in the financial statements is considered to be the most influential in

decision-making, and is of good quality because of its characteristics as a link
between objectives and measurement standards, which are used to assess the level
of quality of information. Decision-makers can choose between different alternatives
by using the qualitative and reliable characteristics of accounting information (Al-
Mahhali, 2009). The primary function and ultimate goal of the financial statement
analysis process is to increase knowledge and reduce uncertainty among users of
this information, helping them to make meaningful decisions within an objective
framework. The financial statements are therefore the best source of information, and
this is because this quantitative blame is verifiable, and one of the main objectives of
the financial statements is to provide information for decision-making.

The analysis of financial statements plays an important role in the preparation of

decisions that concern the financial aspect of the institution, especially on achieving
an effective balance between the elements of assets to work more efficiently, and the
elements of liabilities to reach the lowest cost of funds invested between the centers
of assets and liabilities, and up to the balance of the institution decision (Abu Huwaidi
, 2011). The role that financial information plays in financial decision-making is
therefore fundamentally linked to the horizon. It is well known that accounting
information plays a greater role in short-term decisions than in long-term decisions.
Information forms the key elements in decision-making and forms a link between
accounting and decision-making (Sufian and Sharaa, 2002)

The importance of financial statements can be highlighted in three main elements

(Hamdan, 2013):

First, a communication tool: the role of the financial statements in this area is to
convey a comprehensible message to the user of accounting information about the
activity of the institution and the results of it are thus: a means to link relations
between the institution and suppliers, customers and banks, and a means to provide
information to the various sections of the institution, workers, analysts and
researchers.

Second, a means in assessing performance: where financial statements help in

assessing the performance of management and governance on the efficiency and
use of resources at its disposal, used in judging: the financial position of the
institution, and the progress in achieving the objectives of the institution.

Third, means in making the decisions: Financial statements help management and
various parties dealing with the institution in making the necessary decisions where:
Used in making decisions on how to spend resources in the future, and used from
other parties that have a direct relationship with the institution such as: suppliers,
customers, and banks in guiding the future of their relationships with them.
 5

DISCUSSION

The information in the financial statements is considered to be the most influential in

decision-making, and is of good quality because of its characteristics as a link
between objectives and measurement standards, which are used to assess the level
of quality of information. The primary function and ultimate goal of the financial
statement analysis process is to increase knowledge and reduce uncertainty among
the business entities, helping them to make meaningful decisions within an objective
framework.

The financial statements are therefore the best source of information, and one of the
main objectives of the financial statements is to provide information for decision-
making. The analysis of financial statements plays an important role in the
preparation of decisions that concern the financial aspect of the institution, especially
on achieving an effective balance between the elements of assets to work more
efficiently, and the elements of liabilities to reach the lowest cost of funds invested
between the centers of assets and liabilities, and up to the balance of the institution
decision (Abu Huwaidi , 2011). The role that financial information plays in financial
decision-making is therefore fundamentally linked to the horizon. It is well known that
accounting information plays a greater role in short-term decisions than in long-term
decisions. Information forms the key elements in decision-making and forms a link
between accounting and decision-making (Sufian and Sharaa, 2002).

CONCLUSION

In today's world and studies, it's critical to understand how much of an impact
financial statements have on our organizations, particularly in the investment
decision-making department. Because financial statements represent the firm's
transactions and possession, which is important  for investment selections in that
organization. The aim of the study is to rediscover the following signifance of making
financial statements.

The findings show that the importance of financial statements is summarized in three
main elements. First as a communication tool which is to convey a coherent
information to the user of accounting information about the institution's activity and
results. Second is for assessing the performance, where financial statements come
in handy for evaluating management and governance's performance in terms of
efficiency and resource use, as well as judging the institution's financial situation and
progress toward its goals. And lastly for making decisions in the business, as
financial statements assist management and other parties associated with the
institution in making the essential decisions, such as deciding how to spend
future resources , and guiding the future of their connections with the institution,
including the suppliers, consumers, and banks.

The study contributes to our understanding of the importance of the finanial

statements in the business and how it is fundamental in the day-to-day operations in
the organization. It helps the business to improve appropriate decision-making and
honest information analysis, allowing financial decision-makers to make the best
decisions possible.
 6

RECOMMENDATIONS

Based on the findings, the researcher recommends the following:

1. Conferences and forums should be organized in order to clarify the mechanism of

preparing the financial statements and how to analyze them.

2. It is necessary to make financial decision makers aware of the importance of

financial statements in the financial decision-making process.

3. It is necessary to report the financial statements well that helps the users of the
financial statements to use them at the lowest cost.
 7

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