Financial statements are standardized reports that provide an overview of a company’s financial performance and position.
They are crucial tools for investors, creditors, management, and other stakeholders to assess the company’s profitability, liquidity, solvency, and overall financial health. The main financial statements typically included in the annual report of a company are:
- Balance Sheet (Statement of Financial Position): The balance sheet provides a snapshot of a company’s financial position at a specific point in time, usually at the end of the fiscal year. It presents the company’s assets, liabilities, and shareholders’ equity. Assets are what the company owns, liabilities are what it owes, and shareholders’ equity represents the owners’ residual interest in the company’s assets after deducting liabilities.
- Income Statement (Profit and Loss Statement): The income statement reports a company’s financial performance over a specific period, typically a fiscal quarter or year. It shows the company’s revenues, expenses, and net income (or net loss) during the period. Revenues are the amounts earned from selling goods or providing services, while expenses are the costs incurred in generating revenues.
- Cash Flow Statement: The cash flow statement summarizes a company’s cash inflows and outflows during a specific period, typically classified into operating activities, investing activities, and financing activities. It provides insights into how cash is generated and utilized by the company and helps assess its liquidity and ability to meet short-term obligations.
- Statement of Changes in Equity (Statement of Retained Earnings): The statement of changes in equity shows changes in shareholders’ equity over a specific period, including transactions such as issuance of shares, dividends paid, and changes in retained earnings. It reconciles the beginning and ending balances of shareholders’ equity accounts.
The annual report typically includes these financial statements, along with accompanying notes to the accounts. Notes to the accounts provide additional explanations, details, and disclosures about the information presented in the financial statements. They can help in better understanding the financial statements by providing:
- Accounting Policies: Notes to the accounts disclose the accounting principles and methods used by the company in preparing the financial statements. This includes information about the basis of measurement, valuation of assets and liabilities, revenue recognition criteria, and treatment of significant accounting estimates.
- Significant Accounting Estimates and Judgments: Companies often make estimates and judgments that have a material impact on their financial statements. Notes to the accounts disclose these estimates and judgments, such as provisions for bad debts, impairment of assets, and useful lives of property, plant, and equipment.
- Contingent Liabilities and Commitments: Notes to the accounts disclose contingent liabilities (potential obligations that may arise from past events but are not recognized as liabilities in the financial statements) and commitments (obligations for future transactions). Examples include pending litigation, warranties, and contractual obligations.
- Segment Reporting: For companies operating in multiple business segments or geographical regions, notes to the accounts provide segment-wise financial information, including revenues, expenses, and assets, to facilitate analysis and decision-making.
- Related Party Transactions: Notes to the accounts disclose transactions and relationships between the company and its related parties, such as subsidiaries, associates, joint ventures, key management personnel, and major shareholders. These disclosures help assess the potential impact of related party transactions on the company’s financial position and performance.
In summary, while financial statements provide summarized information about a company’s financial performance and position, notes to the accounts offer additional details, explanations, and disclosures that enhance the transparency and understanding of the financial statements. They play a crucial role in helping stakeholders interpret and analyze the financial information presented in the annual report.