Financial Statements Meaning
Financial statements are similar to report card of students, just like report card at the end of academic year shows how the student has performed over the year in the same way financial statements like profit and loss account and balance sheet of the financial year shows how the company has performed over the year. Financial statements are used by many parties like government, creditors, investors, rating agencies and so on to take stock of company performance and that is the reason why these statements assume a lot of importance. In order to understand more about these statements, one should look at the advantages and disadvantages of financial statements –
Advantages of Financial Statements
Helpful to Investors
Financial statements are of great help not only to current investors who have already invested money into the company but also to prospective investors who are thinking of putting money in the company. Hence if company’s sales, as well as net profits, are growing than it is a good sign and investors can look to invest money into the company but if company’s sales are going down and profits are going up then it may be a warning sign of window dressing or if company’s sales are going up and profits are going down than it signals operational margin problems in the company.
Assistance to Banks and Lending Institutions
Companies seldom operate on their own capital rather they take loans from banks or lending institutions and as far as banks are concerned they decide the quantum of the loan based on past few years financial statements. In simple words just like a blind person without the help of stick find it difficult to move around and may fall in the same way banks need these statements in order to go ahead with giving loan to the companies and without these statements chances of company defaulting on loan of the bank are more as far as banks are concerned.
Guide to Government in Decision Making
Government is the main catalyst for the economy and as far as government is concerned stock market or performance of companies listed in stock market assumes importance because they have to form various policies like fiscal policy, monetary policy, taxation policy keeping in mind the corporate sector and that is where financial statements come into play because these statements are universally accepted and if government wants to check the performance of any company or industry they will look into these statements.
Disadvantages of Financial Statements
Based on Past Data
Financial statements do not reveal the current situation of the company because these statements are based on the past or historical data and if parties like investors, government, banks, creditors want to know the current situation of the company than they will not be able to know much about it based on these statements.
Biased Information
Another limitation of financial statements is that these statements are not completely scientific implying that unlike science where all things are done according to set standards in case of accounting statements companies do not do things according to set standards and adopt a practical approach which results in biasedness creeping in while making these statements. In simple words just like during elections one cannot trust the promises of politicians as politicians make many promises during elections but fulfill only a few promises in the same way one cannot trust these statements completely as the majority of financial statements have an element of window dressing.
Incomplete Information
Another problem with theses statements is that they carry incomplete information because they carry aggregate information rather than showing detailed information which we all know may lead to distortion of facts besides since financial statements carry quantitative information and omit important qualitative information like company’s relations with suppliers, top management behavior, working conditions in the company and so on. In simple words just like all websites do not provide all information for search queries on Google in the same way financial statements do not reveal all data about the company.
As one can see from the above that financial statements have pros as well as cons but one thing is for sure no company or outside parties afford to ignore these statements despite its flaws or limitations because of its universal applicability and widespread use.