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Financial statements (or financial reports) are formal records of the financial activities and position of a business, person, or other entity. Relevant financial information is presented in a structured manner and in a form which is easy to understand. They typically include four basic financial statements accompanied by a management discussion and analysis: # A
balance sheet In financial accounting, a balance sheet (also known as statement of financial position or statement of financial condition) is a summary of the financial balances of an individual or organization, whether it be a sole proprietorship, a busine ...
or statement of financial position, reports on a company's
asset In financial accounting, an asset is any resource owned or controlled by a business or an economic entity. It is anything (tangible or intangible) that can be used to produce positive economic value. Assets represent value of ownership that c ...
s, liabilities, and owners equity at a given point in time. # An
income statement An income statement or profit and loss accountProfessional English in Use - Finance, Cambridge University Press, p. 10 (also referred to as a ''profit and loss statement'' (P&L), ''statement of profit or loss'', ''revenue statement'', ''stateme ...
—or profit and loss report (P&L report), or statement of comprehensive income, or statement of revenue & expense—reports on a company's
income Income is the Consumption (economics), consumption and saving opportunity gained by an entity within a specified timeframe, which is generally expressed in monetary terms. Income is difficult to define conceptually and the definition may be diff ...
,
expense An expense is an item requiring an outflow of money, or any form of Wealth, fortune in general, to another person or group as payment for an item, service, or other category of costs. For a leasehold estate, tenant, renting, rent is an expense. Fo ...
s, and profits over a stated period. A profit and loss statement provides information on the operation of the enterprise. These include sales and the various expenses incurred during the stated period. # A
statement of changes in equity A statement of changes in equity and similarly the statement of changes in owner's equity for a sole trader, statement of changes in partners' equity for a partnership A partnership is an arrangement where parties, known as business partner ...
or statement of equity, or statement of retained earnings, reports on the changes in equity of the company over a stated period. # A
cash flow statement In financial accounting, a cash flow statement, also known as ''statement of cash flows'', is a financial statements, financial statement that shows how changes in balance sheet accounts and income affect cash and cash equivalents, and breaks the ...
reports on a company's
cash flow A cash flow is a real or virtual movement of cash, money: *a cash flow in its narrow sense is a payment (in a currency), especially from one central bank account to another; the term 'cash flow' is mostly used to describe payments that are exp ...
activities, particularly its operating,
investing Investment is the dedication of money to purchase of an asset to attain an increase in value over a period of time. Investment requires a sacrifice of some present asset, such as time, money, or effort. In finance, the purpose of investing is ...
and
financing Funding is the act of providing resources to finance a need, program, or project. While this is usually in the form of money, it can also take the form of effort or time from an organization or company. Generally, this word is used when a firm us ...
activities over a stated period. # A comprehensive income statement involves those other comprehensive income items which are not included while determining net income. (Notably, a balance sheet represents a ''single point in time'', whereas the income statement, the statement of changes in equity, and the cash flow statement each represent activities over a stated ''period''.) For large corporations, these statements may be complex and may include an extensive set of footnotes to the financial statements and management discussion and analysis. The notes typically describe each item on the balance sheet, income statement and cash flow statement in further detail. Notes to financial statements are considered an integral part of the financial statements.


Purpose for financial statements

"The objective of financial statements is to provide information about the financial position, performance and changes in financial position of an enterprise that is useful to a wide range of users in making economic decisions." Financial statements should be understandable, relevant, reliable and comparable. Reported assets, liabilities, equity, income and expenses are directly related to an organization's financial position. Financial statements are intended to be understandable by readers who have "a reasonable knowledge of business and economic activities and accounting and who are willing to study the information diligently.""The Framework for the Preparation and Presentation of Financial Statements"
International Accounting Standards Board. Accessed 24 June 2007.
Financial statements may be used by users for different purposes: *Owners and managers require financial statements to make important business decisions that affect its continued operations.
Financial analysis Financial analysis (also known as financial statement analysis, accounting analysis, or analysis of finance) refers to an assessment of the viability, stability, and profitability of a business, sub-business or project. It is performed by profes ...
is then performed on these statements to provide management with a more detailed understanding of the figures. These statements are also used as part of management's annual report to the stockholders. *Employees also need these reports in making
collective bargaining Collective bargaining is a process of negotiation between employers and a group of employees aimed at agreements to regulate working salaries, working conditions, benefits, and other aspects of workers' compensation and rights for workers. The i ...
agreements (CBA) with the management, in the case of
labor unions A trade union (labor union in American English), often simply referred to as a union, is an organization of workers intent on "maintaining or improving the conditions of their employment", ch. I such as attaining better wages and Employee ben ...
or for individuals in discussing their compensation, promotion and rankings. *Prospective
investor An investor is a person who allocates financial capital with the expectation of a future Return on capital, return (profit) or to gain an advantage (interest). Through this allocated capital most of the time the investor purchases some specie ...
s make use of financial statements to assess the viability of investing in a business. Financial analyses are often used by investors and are prepared by professionals (financial analysts), thus providing them with the basis for making investment decisions. *Financial institutions (banks and other lending companies) use them to decide whether to grant a company with fresh
working capital Working capital (WC) is a financial metric which represents operating liquidity available to a business, organisation, or other entity, including governmental entities. Along with fixed assets such as plant and equipment, working capital is consi ...
or extend debt
securities A security is a tradable financial asset. The term commonly refers to any form of financial instrument, but its legal definition varies by jurisdiction. In some countries and languages people commonly use the term "security" to refer to any for ...
(such as a long-term
bank loan In finance, a loan is the lending of money by one or more individuals, organizations, or other entities to other individuals, organizations, etc. The recipient (i.e., the borrower) incurs a debt and is usually liable to pay interest on that de ...
or
debenture In corporate finance, a debenture is a medium- to long-term debt financial instrument, instrument used by large companies to borrow money, at a fixed rate of interest. The legal term "debenture" originally referred to a document that either creat ...
s) to finance expansion and other significant expenditures.


Consolidated

Consolidated financial statements are defined as "Financial statements of a group in which the
asset In financial accounting, an asset is any resource owned or controlled by a business or an economic entity. It is anything (tangible or intangible) that can be used to produce positive economic value. Assets represent value of ownership that c ...
s, liabilities, equity,
income Income is the Consumption (economics), consumption and saving opportunity gained by an entity within a specified timeframe, which is generally expressed in monetary terms. Income is difficult to define conceptually and the definition may be diff ...
,
expense An expense is an item requiring an outflow of money, or any form of Wealth, fortune in general, to another person or group as payment for an item, service, or other category of costs. For a leasehold estate, tenant, renting, rent is an expense. Fo ...
s and
cash flow A cash flow is a real or virtual movement of cash, money: *a cash flow in its narrow sense is a payment (in a currency), especially from one central bank account to another; the term 'cash flow' is mostly used to describe payments that are exp ...
s of the parent (company) and its
subsidiaries A subsidiary, subsidiary company or daughter company is a company (law), company owned or controlled by another company, which is called the parent company or holding company. Two or more subsidiaries that either belong to the same parent company ...
are presented as those of a single
economic entity In accounting, an economic entity is one of the assumptions made in generally accepted accounting principles. Almost any type of organization or unit in society can be an economic entity. Examples of economic entities are hospitals, companies, m ...
", according to International Accounting Standard 27 "Consolidated and separate
financial Finance is the study and discipline of money, currency and capital assets. It is related to, but not synonymous with economics, the study of Production (economics), production, Distribution (economics), distribution, and Consumption (economics) ...
statements", and
International Financial Reporting Standard International Financial Reporting Standards, commonly called IFRS, are accounting standard Publicly traded companies typically are subject to rigorous standards. Small and midsized businesses often follow more simplified standards, plus any spec ...
10 "Consolidated financial statements".


Government

The rules for the recording, measurement and presentation of government financial statements may be different from those required for business and even for non-profit organizations. They may use either of two
accounting methods A basis of accounting is the time various financial transactions are recorded. The cash basis (EU VAT vocabulary ''cash accounting'') and the accrual basis are the two primary methods of tracking income and expenses in accounting. Both can ...
: accrual
accounting Accounting, also known as accountancy, is the measurement, processing, and communication of financial and non financial information about economic entity, economic entities such as businesses and corporations. Accounting, which has been calle ...
, or cost accounting, or a combination of the two ( OCBOA). A complete set of
chart of accounts A chart of accounts (COA) is a list of financial Account (bookkeeping), accounts set up, usually by an accountant, for an organization, and available for use by the bookkeeper for recording transactions in the organization's general ledger. Acc ...
is also used that is substantially different from the chart of a profit-oriented business.


Personal

Personal financial statements may be required from persons applying for a
personal loan Personal may refer to: Aspects of persons' respective individualities * Privacy * Personality * Personal, personal advertisement, variety of classified advertisement used to find romance or friendship Companies * Personal, Inc., a Washingt ...
or
financial aid Student financial aid in the United States is funding that is available exclusively to students attending a Higher education in the United States, post-secondary educational institution in the United States. This funding is used to assist in cov ...
. Typically, a personal financial statement consists of a single form for reporting personally held assets and liabilities (debts), or personal sources of income and expenses, or both. The form to be filled out is determined by the organization supplying the loan or aid.


Audit and legal implications

Although laws differ from country to country, an
audit An audit is an "independent examination of financial information of any entity, whether profit oriented or not, irrespective of its size or legal form when such an examination is conducted with a view to express an opinion thereon.” Auditing ...
of the financial statements of a
public company A public company is a company whose ownership is organized via shares of share capital, stock which are intended to be freely traded on a stock exchange or in Over-the-counter (finance), over-the-counter markets. A public (publicly traded) comp ...
is usually required for investment, financing, and tax purposes. These are usually performed by independent accountants or auditing firms. Results of the audit are summarized in an audit report that either provide an unqualified opinion on the financial statements or qualifications as to its fairness and accuracy. The audit opinion on the financial statements is usually included in the annual report. There has been much legal debate over who an auditor is liable to. Since audit reports tend to be addressed to the current shareholders, it is commonly thought that they owe a legal duty of care to them. But this may not be the case as determined by common law precedent. In Canada, auditors are liable only to investors using a prospectus to buy shares in the primary market. In the
United Kingdom The United Kingdom of Great Britain and Northern Ireland, commonly known as the United Kingdom (UK) or Britain, is a country in Europe, off the north-western coast of the European mainland, continental mainland. It comprises England, Scotlan ...
, 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 An unlimited company or private unlimited company is a hybrid company A company, abbreviated as co., is a legal entity representing an association of people, whether natural, legal or a mixture of both, with a specific objective. Comp ...
. In the
United States The United States of America (U.S.A. or USA), commonly known as the United States (U.S. or US) or America, is a country Continental United States, primarily located in North America. It consists of 50 U.S. state, states, a Washington, D.C., ...
, especially in the post-
Enron Enron Corporation was an American Energy development, energy, Commodity, commodities, and services company based in Houston, Texas. It was founded by Kenneth Lay in 1985 as a merger between Lay's Houston Natural Gas and InterNorth, both relativ ...
era there has been substantial concern about the accuracy of financial statements. Corporate officers—the
chief executive officer A chief executive officer (CEO), also known as a central executive officer (CEO), chief administrator officer (CAO) or just chief executive (CE), is one of a number of Corporate Executive, corporate executives charged with the management of an or ...
(CEO) and
chief financial officer The chief financial officer (CFO) is an Corporate title, officer of a company or organization that is assigned the primary responsibility for managing the company's finance, finances, including financial planning, management of financial risks, r ...
(CFO)—are personally responsible for fair financial reporting that provides an accurate sense of the organization to those reading the report.


Standards and regulations

Different countries have developed their own accounting principles over time, making international comparisons of companies difficult. To ensure uniformity and comparability between financial statements prepared by different companies, a set of guidelines and rules are used. Commonly referred to as
Generally Accepted Accounting Principles Publicly traded companies typically are subject to rigorous standards. Small and midsized businesses often follow more simplified standards, plus any specific disclosures required by their specific lenders and shareholders. Some firms operate on th ...
(GAAP), these set of guidelines provide the basis in the preparation of financial statements, although many companies voluntarily disclose information beyond the scope of such requirements.FASB, 2001
Improving Business Reporting: Insights into Enhancing Voluntary Disclosures
Retrieved on April 20, 2012.
Recently there has been a push towards standardizing accounting rules made by the
International Accounting Standards Board The International Accounting Standards Board (IASB) is the independent accounting standard-setting body of the IFRS Foundation. The IASB was founded on April 1, 2001, as the successor to the International Accounting Standards Committee (IASC). It ...
(IASB). IASB develops
International Financial Reporting Standards International Financial Reporting Standards, commonly called IFRS, are accounting standards issued by the IFRS Foundation and the International Accounting Standards Board (IASB). They constitute a standardised way of describing the company's fina ...
that have been adopted by
Australia Australia, officially the Commonwealth of Australia, is a sovereign country comprising the mainland of the Australian continent, the island of Tasmania, and numerous smaller islands. With an area of , Australia is the largest country by ...
, Canada and the
European Union The European Union (EU) is a supranational union, supranational political union, political and economic union of Member state of the European Union, member states that are located primarily in Europe, Europe. The union has a total area of ...
(for publicly quoted companies only), are under consideration in
South Africa South Africa, officially the Republic of South Africa (RSA), is the Southern Africa, southernmost country in Africa. It is bounded to the south by of coastline that stretch along the Atlantic Ocean, South Atlantic and Indian Oceans; to the ...
and
other countries Other often refers to: * Other (philosophy), a concept in psychology and philosophy Other or The Other may also refer to: Film and television * The Other (1913 film), ''The Other'' (1913 film), a German silent film directed by Max Mack * The Oth ...
. The
United States The United States of America (U.S.A. or USA), commonly known as the United States (U.S. or US) or America, is a country Continental United States, primarily located in North America. It consists of 50 U.S. state, states, a Washington, D.C., ...
Financial Accounting Standards Board The Financial Accounting Standards Board (FASB) is a private standard-setting body whose primary purpose is to establish and improve Generally Accepted Accounting Principles (GAAP) within the United States in the public's interest. The Securi ...
has made a commitment to converge the U.S. GAAP and IFRS over time.


Inclusion in annual reports

To entice new investors, 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 organization in a "marketing
brochure A brochure is originally an Information, informative paper document (often also used for advertising) that can be folded into a template, pamphlet, or Folded leaflet, leaflet. A brochure can also be a set of related unfolded papers put into a po ...
" of sorts. Usually the company's chief executive will write a letter to shareholders, describing management's performance and the company's financial highlights. In the United States, prior to the advent of the internet, the annual report was considered the most effective way for corporations to communicate 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 A coffee table book, also known as a cocktail table book, is an oversized, usually hardcover, hard-covered book whose purpose is for display on a coffee table, table intended for use in an area in which one entertains guests and from which it can ...
.


Notes

Additional information added to the end of financial statements that help explain specific items in the statements as well as provide a more comprehensive assessment of a company's financial condition are known as notes (or "notes to financial statements"). Notes to financial statements can include information on
debt Debt is an obligation that requires one party, the debtor, to pay money or other agreed-upon value to another party, the creditor. Debt is a deferred payment, or series of payments, which differentiates it from an immediate purchase. The de ...
, accounts, contingent liabilities, on
going concern A going concern is a business that is assumed will meet its financial obligations when they become due. It functions without the threat of liquidation for the foreseeable future, which is usually regarded as at least the next 12 months or the spec ...
criteria, or on contextual information explaining the financial numbers (e.g. to indicate a lawsuit). The notes clarify individual statement line-items. Notes are also used to explain the accounting methods used to prepare the statements and they support valuations for how particular accounts have been computed. As an example: If a company lists a loss on a
fixed asset A fixed asset, also known as long-lived assets or property, plant and equipment (PP&E), is a term used in accounting for assets and property that may not easily be converted into cash. Fixed assets are different from current assets, such as cash ...
impairment line in their income statement, the notes may state the reason for the impairment by describing how the asset became impaired. In
consolidated financial statement Consolidated financial statements are the "financial statements Financial statements (or financial reports) are formal records of the financial activities and position of a business, person, or other entity. Relevant financial information is ...
s, all
subsidiaries A subsidiary, subsidiary company or daughter company is a company (law), company owned or controlled by another company, which is called the parent company or holding company. Two or more subsidiaries that either belong to the same parent company ...
are listed as well as the amount of ownership (
controlling interest A controlling interest is an ownership interest in a corporation with enough voting Share capital, stock shares to prevail in any stockholders' motion. A majority of voting shares (over 50%) is always a controlling interest. When a party holds less ...
) that the
parent company A holding company is a company whose primary business is holding a controlling interest in the securities of other companies. A holding company usually does not produce goods or services itself. Its purpose is to own shares of other companies ...
has in the subsidiaries. Any items within the financial statements that are valuated by estimation are part of the notes if a substantial difference exists between the amount of the estimate previously reported and the actual result. Full disclosure of the effects of the differences between the estimate and actual results should be included.


Management discussion and analysis

Management discussion and analysis or MD&A is an integrated part of a company's annual financial statements. The purpose of the MD&A is to provide a narrative explanation, through the eyes of management, of how an entity has performed in the past, its financial condition, and its future prospects. In so doing, the MD&A attempt to provide investors with complete, fair, and balanced information to help them decide whether to invest or continue to invest in an entity. The section contains a description of the year gone by and some of the key factors that influenced the business of the company in that year, as well as a fair and unbiased overview of the company's past, present, and future. MD&A typically describes the corporation's liquidity position, capital resources, results of its operations, underlying causes of material changes in financial statement items (such as asset impairment and restructuring charges), events of unusual or infrequent nature (such as
mergers and acquisitions Mergers and acquisitions (M&A) are business transactions in which the ownership of Company, companies, other business organizations, or their operating units are transferred to or Consolidation (business), consolidated with another company or b ...
or share buybacks), positive and negative trends, effects of
inflation In economics, inflation is an increase in the general price level of goods and services in an economy. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation corresponds to a reductio ...
, domestic and international market risks, and significant uncertainties.


Move to electronic statements

Financial statements have been created on paper for hundreds of years. The growth of the Web has seen more and more financial statements created in an electronic form which is exchangeable over the Web. Common forms of electronic financial statements are PDF and HTML. These types of electronic financial statements have their drawbacks in that it still takes a human to read the information in order to reuse the information contained in a financial statement. More recently a market driven global standard, XBRL (Extensible Business Reporting Language), which can be used for creating financial statements in a structured and computer readable format, has become more popular as a format for creating financial statements. Many regulators around the world such as the U.S. Securities and Exchange Commission have mandated XBRL for the submission of financial information. The
UN/CEFACT UN/CEFACT is the United Nations Centre for Trade Facilitation and Electronic Business. It was established as an intergovernmental body of the United Nations Economic Commission for Europe (UNECE) in 1996 and evolved from UNECE's long tradition of w ...
created, with respect to Generally Accepted Accounting Principles ( GAAP), internal or external
financial reporting Financial statements (or financial reports) are formal records of the financial activities and position of a business, person, or other entity. Relevant financial information is presented in a structured manner and in a form which is easy to un ...
XML Extensible Markup Language (XML) is a markup language and file format for storing, transmitting, and reconstructing arbitrary data. It defines a set of rules for encoding electronic document, documents in a format that is both Human-readable med ...
messages to be used between enterprises and their partners, such as private interested parties (e.g. bank) and public collecting bodies (e.g. taxation authorities). Many regulators use such messages to collect financial and economic information.


See also

* Accountable Fundraising * Corporate financial accounting * Financial statement analysis * Comprehensive annual financial report * Model audit


References


Further reading

* Alexander, D., Britton, A., Jorissen, A., "International Financial Reporting and Analysis", Second Edition, 2005,


External links


IFRS Foundation & International Accounting Standards BoardFinancial Accounting Standards Board
(U.S.)

*
Fundamental Analysis: Notes To The Financial Statements
by Investopedia.com {{Authority control Financial statements