Financial Statements Concept Explained: 3 Types of Financial Statements

January 9, 2022
Financial Statements Concept Explained: 3 Types of Financial Statements

The financial statements are formal annual reports through which firm disseminates its financial information to various stakeholders like owners, investors, tax authorities, employees etc. it is the basis to understand the profitability and financial position of any firm. It is the basis for taking decisions.

It represents recorded facts expressed in monetary terms for defined period of time.

Financial statements are prepared following accounting policies consistently accounting standards prescribed in the Companies Act and accounting concepts, principles, procedures and also the legal environment in which the business organizations operate.

Objectives of Financial Statements

The objectives of financial statements are:

  • To provide information about economic resources and obligations of a firm. It provides insights to those stakeholders who have limited authority, ability or resources to obtain information about the firm.
  • To provide information about the earning capacity of the business. It is helpful to predict, compare and evaluate the business firm’s earning capacity
  • To provide information about cash flows. It helps investors and creditors to predict, compare and evaluate, potential cash flows in terms of amount, timing and related uncertainties
  • To judge effectiveness of management in utilising the resources of a business effectively
  • To provide information about activities of business affecting the society. It helps in social impact analysis.
  • To disclose the accounting policies followed.

Types of Financial Statements

There are three types of financial statements:

  1. Balance Sheet: It provides the financial position of firm at given point of time.
  2. Profit and Loss statement: It depicts the performance of firm over the period of time.
  3. Cash flow statement: It provides the sources and uses of cash during the given period of time. It depicts the movements of funds and changes in the financial position of the company

Every company registered under The Companies Act 2013 have to prepare these statements to harmonise the disclosure requirement with the accounting standards

Functions of Financial Statements

The functions of financial statements are:

  • It provides us the information about the performance of firm in past and current financial position of business
  • It is an important financial document for stakeholders, creditors, regulators and others to measure the financial performance and position of firm
  • It helps in financial forecasting, planning, decision-making and control

Basic Accounting Concepts for Preparation of Financial Statement

The following concepts and principles are central to the preparation of financial accounts and statements are:

  1. Going Concern Principle: The Going Concern principle assumes that the business shall continue to exist and operate for the foreseeable future without need or intention to liquidate or curtail its operational activities.
  2. Consistency Principle: There should be consistency in accounting treatment of items in different periods. There should be uniformity in accounting policies and processes from one period to another. The consistency makes the financial statements uniform and comparable.
  3. Prudence Principle: The Prudence principle states that profits will not be recognised until that are realised. Further, the losses will be recognised as soon as they are appeared even though they are not realised.
  4. Accrual Principle: The Accrual principle states that revenue is recognised when it is realised and not when it is actually received. Similarly, the cost of earning the revenue is to be recognised when it is incurred and not when it is paid.
  5. Entity Concept: According to Entity principle, a business entity is considered separate from its owners. While preparing financial statements of business, the personal assets and liabilities of owners should not be considered.
  6. Dual Aspect Principle: As per Dual Aspect principle, the assets owned by business is equal to liabilities owed.

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