What are Financial Statements?

At the heart of understanding a company's financial health lies a crucial tool – financial statements. If you've ever found yourself wondering about the numbers and terms thrown around in annual reports or business discussions, you're not alone. In this article, we'll unravel the mystery behind each financial statement, breaking down their significance, components, and how they serve as invaluable guides for both seasoned and new investors.

What are Financial Statements? 

Financial statements are the vital documents through which a company communicates its financial performance and position to its stakeholders. The role of financial statement analysis is to use the information in a company’s financial statements, along with other relevant information, to make investment decisions. 

Investors aren't the sole users of financial statements; a company's management also relies on them to guide financial decision-making. Creditors use these statements to check if the company will be able to repay the loan along with interest on time. Investors use them to understand the company’s ability to earn profits and generate cash flow in the future. 

How are Financial Statements Prepared?

Financial statements are prepared using financial reporting standards. They provide principles for creating financial reports and determine the types & quantity of information that must be provided to those who use them. Institutions such as the International Accounting Standards Board (IASB) and Financial Accounting Standards Board (FASB) create these standards. These organisations are typically private sector and self-regulated. Their board members include experienced accountants, auditors, users of financial statements, and academicians. 

Most countries follow the International Financial Reporting Standards (IFRS) developed by IASB. These standards ensure quality in the financial statements. Relevance, faithful representation, comparability, verifiability, timeliness, and understandability are the primary qualities of financial statements. 

Regulatory authorities such as SEBI in India and SEC in the US ensure that these financial statements are prepared properly.

What are the Different Financial Statements?

There are five important financial statements for a company. They are:

1. Statement of Profit & Loss

2. Statement of Financial Position (Balance Sheet)

3. Statement of Cash Flows 

4. Statement of Changes in Equity

5. Notes to Accounts

Notes to accounts or footnotes are a part of the financial statements which show the details of each item. 

Standalone vs Consolidated Financial Statement

Companies with subsidiaries have two sets of financial statements in their annual report: standalone financial statements and consolidated financial statements. Standalone financial statements only include the financials of the company itself and do not include the financials of their subsidiaries. Consolidated financial statements include the financials of the company along with its subsidiaries. 

For example, Company B is a subsidiary of Company A. The standalone financial statements of Company A include only the transactions specific to Company A. On the other hand, in consolidated financial statements, the transactions of both Company A and Company B are included.

We always consider the consolidated financial statements because the business transactions of the subsidiary also affect its parent company, as the ownership lies with the company.

In conclusion, financial statements are strategic roadmaps. The numbers might look a bit tricky at first, but once you get the hang of it, you're in control. Armed with this knowledge, you will be better equipped to navigate the complex landscape of financial decisions. So, as you delve into the world of balance sheets, income statements, and cash flow reports, may your financial wisdom soar, and your decisions stand on solid ground.

Also read:
1. What is a Statement of Profit & Loss?

2. What is a Balance Sheet?

3. What is Cash Flow Statement?