Purpose of financial statements
Financial statements are a very important tool for all businesses, as they allow shareholdersA part owner of a private or public limited company., managers and investors to make informed future business decisions and understand the performance of the business over time. By interpreting financial statements, businesses are able to move in a direction to improve their finances and secure the future of a business.
With certain types of business ownership, such as public limited companyA company where shares are offered to the public. and private limited companies A private limited company has limited liability. Often, these types of business have ‘Ltd’ after their business name. companies, producing financial statements is also a legal requirement. Failure to create such documents can have severe sanctions, such as fines.
There are two main financial statements used in business, the income statement and the statement of financial position, or balance sheet. These two financial statements give a range of business stakeholders an understanding of the financial performance of a business at a given point in time. As part of these financial documents, businesses will also consider their gross profitGross profit is the difference between the money received from selling goods and services and the cost of making or providing them. It ignores any fixed costs or overheads. and net profit marginThe proportion of sales revenue that is left once all costs have been paid., two key pieces of financial information required to understand business performance.
Financial statements have a range of advantages:
- they allow a business to spot trends
- they allow comparison with other businesses
- they give a clear financial overview of the business
There are also some drawbacks:
- they can be time consuming to prepare
- they make it difficult to hide financial information from competitors or potential investors
