The Importance of Financial Statements

The importance of a company’s financial statements cannot be overstated as they provide vital information concerning business performance and overall financial health.  Data from day-to-day bookkeeping entries which manage financial inflows and outflows is used to compile these mission critical reports.  The information provided is useful in a number of ways including marketing decisions, assessing ROI, decisions related to expansion and financing, benchmarking, and future financial projection.  Financial statements are also great tools to communicate to external stakeholders such as investors, creditors, and financial analysts.

The Balance Sheet

The Balance Sheet is a snapshot of a given company’s financial position at a particular moment in time.  The asset section lists everything your company owns, such as cash on hand, inventory, real estate holdings, and accounts receivable.  The liabilities section lists everything your business owes, such as loan obligations, payroll responsibilities, and accounts payable.  The single most important piece of info provided from this statement is the owner’s equity, also referred to as net worth, which is the result of subtracting liabilities from assets.

The Income Statement

Given that the balance sheet is a snapshot in time, it fails to shed light on what actually happened in the period that caused the company to reach its current position.  As a result, profit figures from the income statement become especially important to investors and creditors.  The information provided within this statement contains different sources of operating income, expenditures, losses, and profits.  Using these statements appropriately can aid investors in assessing past performance and projecting future cash flows.  The most valuable information gleaned is ultimately net income which informs you as to whether or not your business is in the black.

Statement of Cash Flows  

Complementing the balance sheet and the income statement, the Cash Flow Statement has been a mandatory part of a company’s financial reports since 1987.  It illustrates all cash inflows and outflows associated with the business during a specific financial period.  The statement has three main categories (operating, investing, financing) and is used by investors to assess whether a company has enough incoming funds to pay for its operating expenses and purchases.  When compared to the income statement, it is especially useful as reported profit and loss does not always reflect the cash flows experienced by the business.

Statement of Owner’s Equity

The statement of shareholder’s equity is of primary importance to equity investors because it shows the net change in equity elements, including retained earnings, over a given financial period.  Shareholder’s equity is calculated by subtracting liabilities from assets and represents the company’s net worth.  The report format varies in structure, but can include the sale or repurchase of shares, dividend payments, changes caused by reported loss/profit, changes to accounting policies, and correction of accounting errors.  This report is often the least used of all the financial statements and is typically only issued in the audited financial statement package.