Financial statements
Encyclopedia : F : FI : FIN : Financial statements
Financial statements (or financial reports) are a record of a business' financial flows and levels.
The big four statements are :
- Balance Sheet which describes a company's assets and liabilities.
- Income statement which describes a company's income and expenses.
- Statement of Cash Flows which describes how corporate operating, investment, and financing activities have affected the company's cash position.
- Statement of Retained Earnings which describes changes to shareholders equity (for example a payment of dividend).
If a company has extraordinary items that affect the balance sheet or the shareholders equity position it will usually include a Other Comprehensive Income Statement, which describes the adjustments to made. Examples of Other Comprehensive Income include revaluation of corporate assets away from their stated cost, as well as accrurals for liabilities.
Today most governments require publicly-traded companies to issue, and issue in a certain way, annual financial statements. Some governments, such as the United Kingdom government, require all companies to publish annual financial statements, although smaller companies only need publish them in abbreviated form.
Government Financial statements
These are usually in the annual financial report for the year. The financial statements, in contrast to the budget, present the revenue collected and amounts spent. When done on an accrual basis, it is the economic event that is important. For instance, even if cash is yet not spent for supplies, what counts in accrual is the amount of supplies or some other asset used. The government financial statements usually include a statement of activities (similar to an income statement in the private sector), a balance sheet and often some type of reconciliation. The reconciliation is needed on two different bases, such as accrual and cash, and used in different reports. Cash flow statements are often included. These show the sources of the revenue and the destination of the expenses.History
Financial statements and records have been produced for as far back as there has been human writing. The people in the old Mesopotamian societies operated both insurance and credit (see interest) corporations, and had the obvious need of record keeping.Financial condition
Each statement presents financial data relating to a company's or a group's current financial health, business results for the previous period, and other indicators that are used by the company's stakeholders to assess the health of a company. Typically a company's stakeholders will include existing and prospective shareholders, employees and trades unions, the taxation authorities, banks, suppliers and customers.Usually the most broad requirement is that financial statements should be true and fair. This has not always been the case in the past: for instance, in the UK the requirement used to be true and correct.
Promotion
To entice new investors, most public companies assemble their financial statements on fine paper with pleasing graphics and photos in an annual report to shareholders, attempting to capture the excitement and culture of the organisation in a "marketing brochure" of sorts. Usually the company's chief executive will write a letter to shareholders, describing the financial year in the most favorable light.In the United States, prior to the advent of the internet, the annual report was the main way that a corporation communicated with individual shareholders. Blue chip companies went to great expense to produce and mail out attractive annual reports to every shareholder. The annual report was often prepared in the style of a coffee table book
Audit
Although the rules differ between jurisdictions, usually larger companies, and all publicly-quoted companies must have their financial statements independently audited. Note that the auditors do not certify financial statements, that is done by the company's directors. All an auditor does is examine the financial statements and records of a company and opines on whether they do indeed show a "true and fair" view (or meet other particular requirements that the auditor is engaged to opine on).There has been much legal debate over who an auditor is liable to. Since audit reports tend to be addressed to the current shareholders, there is little doubt that they owe a legal duty of care to them. In the UK, they have been held liable to potential investors when the auditor was aware of the potential investor and how they would use the information in the financial statements. Nowadays auditors tend to include in their report liability restricting language, discouraging anyone other than the addressees of their report from relying on it. Liability is an important issue: in the UK, for example, auditors have unlimited liability.
In the United States, especially in the post-Enron era there has been substantial concern about the accuracy of financial statements. Corporate officiers (the CEO and CFO) are personally liable for attesting that financial statements "do not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by th[e] report". Making or certifiing misleading financial statements exposes the people involved to substantial civil and criminal liability. For example Bernie Ebbers (former CEO of WorldCom) was sentenced to 25 years in federal prison for allowing WorldCom's revenues to be overstated by $11 billion over five years.
System
Financial statements can also be representations of business structures as recorded in a double-entry book-keeping system, and are used to support internal record-keeping and decision-making. While businesses are not obligated to use this format internally, most do keep its basic structure because it is well-understood by employees and well-supported by information systems. In this format, businesses view their financial condition in terms of assets, liabilities, and equity. Transactions consist of debits and credits.Standards and regulation
To ensure that financial statements prepared by different companies can be adequately compared, they must be prepared according to certain rules. Countries under the common law legal system usually follow guidelines set in generally accepted accounting principles ("GAAP"). National accounting bodies in each country have developed their own specific sets of accounting principles. The most common internationally GAAP are U.S. generally accepted accounting principles and UK generally accepted accounting principles.Different countries have developed their own accounting principles over time, making international comparisons of companies difficult. Recently there has been a push towards standardising accounting rules made by the International Accounting Standards Board ("IASB"). IASB develops International Financial Reporting Standards that have been adopted by Australia and the European Union (for publicly-quoted companies only), are under consideration in South Africa and other countries. The United States Federal Accounting Standards Board has made a commitment to converge the US GAAP and IFRS over time [link].
See also
- Accounting
- Auditing
- Corporate finance
- Generally accepted accounting principles
- International Financial Reporting Standards
Guides
- [September 14, 2004 - Reading An Earnings Release - Glenn Schorr, CFA, Executive Director, Financials Group, UBS]
- [SEC.gov - Information matters]
External links
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