Objectives of Financial Statements

What are the Objectives of Financial Statements?

The primary objective of financial statement is to provide financial information about the company such that it can help the stakeholders and other users take economic decisions including past performance and current position assessment, predict and judge company’s growth and predict its situation on bankruptcy or any kind of failure.

Explanation of Financial Statement Objectives / Purposes

Objectives of Financial Statements

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Source: Objectives of Financial Statements (wallstreetmojo.com)

#1 – Past Performance and Current Position Assessment

The primary objective is to depict past performance. The future performance of the organization is dependent on past performance. On the other hand, the other is to represent the current position where the business stands in the present scenario. It may show the types of assets owned by a business and the li­abilities due to a business entity.

It also explains the cash position and the mix of debt and equity available with the organization.

Practical Application

An investor or creditor is always keenly interested in the trend of sales, net income, expenses, cash flowCash FlowCash Flow is the amount of cash or cash equivalent generated & consumed by a Company over a given period. It proves to be a prerequisite for analyzing the business’s strength, profitability, & scope for betterment. read more, and the organization’s return on investment as a whole. These trends are beneficial for judging management’s past performance and thus serve as possible indicators of the future performance of the entity. Assessment of Past Performance and Current Position is very crucial for financial transparency required by various decision-makers.

#2 – Prediction of Net Income and Judging the Growth

The objective of the financial statement lies in predicting the earning prospects of net income and also judge the growth of the business.

  • The financial statement helps in planning and forecasting. Financial statements help the management to adopt an appropriate business policy by making it requires comparisons among various peer organizations. It helps in forecasting and preparing budgets by providing information regarding the strengths and weaknesses of the business.
  • Thus the importance of financial statements to management is that it helps in communicating with different parties about their financial position.  The CFO refers to financial reports to make dividend-related decisions. He would look at the profits made, the debts to be paid off, the provisions made for reserves, and decide the dividend to be distributed.
Practical Application

By comparing data of two or more years of business entity, a growth trend can be concluded. For example, if there is an increase in sales with an increase in profits, it can be concluded that the business state is healthy.

Investors, while comparing investment alternatives, are considerate of the risk or uncertainty associated with the business’s expected return.

#3 – Prediction of the Bankruptcy of a Business Entity and another Failure

It helps keep track of the solvency of the business. It helps in predicting the bankruptcy and failure probability of business enterprises. The capacity of the entity to repay its short and long term liabilitiesLong Term LiabilitiesLong Term Liabilities, also known as Non-Current Liabilities, refer to a Company’s financial obligations that are due for over a year (from its operating cycle or the Balance Sheet Date). read more must always be known.

Practical Application

Both managers and investors can take preventive measures to avoid or minimize losses so that solvencySolvencySolvency of a company means its ability to meet the long term financial commitments, continue its operation in the foreseeable future and achieve long term growth. It indicates that the entity will conduct its business with ease.read more is maintained. Corporate management can bring changes in operating policy, financial structureFinancial StructureThe financial structure refers to the sources of capital and the proportion of financing that comes from short term liabilities, short term debt, long term debt, and equity to fund the company's long term and short term working capital requirements.read more, or other required changes that can be incorporated.

#4 – Help Stakeholders and other users to make Economic Decisions

It provides essential information required by stakeholders so that they can take various economic decisions like the one about the financial position of the enterprise.

  • Financial institutions, like banks and other lending companies, use it to make loan decisions or other credit decisions. It helps to decide whether to grant working capital, extend debts such as a long-term loan or debentures to finance expansion and other expenditures or not. If yes, financial statement helps in determining credit risk associated, deciding terms for the lending and conditions of loan like collateral, interest rate, and maturity date. Thus, creditors use financial reports widely to assess the creditworthiness of the organization.
  • Prospective investors use financial reports to assess the viability of investing in a business. Financial analysis is often used by investors and is prepared by professionals like financial analysts. Thus the importance of the financial statement is that it helps them in making investment decisions.

Conclusion

Financial statements are a critical factor in ensuring that the actual financial picture of the business is presented to management and external stakeholders. It not only opens a window for known and educated decision-making and strategic planning for stakeholders, but financial statements also aim at mitigating errors that may arise due to discrepancies of numbers in various financial statements.

Understanding the basic financial statementsBasic Financial StatementsFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels.read more is a necessary step towards the successful management of an enterprise.

Also, accurate financial statements induce trust in the company. Building trust is also a very crucial objective of financial statements.

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