Financial statements accurately reflect a company’s financial position and performance and are a vital part of any well-run business. Regardless of the size of your business or industry, financial statements help in efficient management, and the understanding they bring can help a business to grow.
A company’s financial statements need to be updated and completed regularly. These financial statements encompass the central part of your business plan, which plays an integral role in helping you secure loans or investments needed to grow your enterprise. Additionally, the statements help stakeholders, including investors, management, and financial analysts, assess and fully understand the financial state of a business.
Any business decision made by management has financial implications. The financial standing and profitability of the company as well as insights into its financial health, are highlighted by the financial statements. They help assess the company’s past performance and aid in forecasting future cash flows.
Financial management skills are essential to any business owner- they help you comprehend and use financial data to grow your business. These skills can be developed with the help of an MSc finance online course such as that offered by Aston University. The program is designed for individuals who want to pursue a career in finance and also need the flexibility to complete their degree online. It gives students a solid foundation in finance, with courses covering topics such as financial accounting, financial markets and institutions, investment analysis, and portfolio management.
Financial statements explained
There are several kinds of financial statements, starting with the balance sheet, income statement, and cash flow statement. They provide a snapshot of the company’s past performance and current state of profitability, data that can be utilised by senior management to assist with decision-making.
In addition to strategic management skills, financial statements provide information essential for formulating strategies that lead to the company’s growth. The data from financial statements reflect the performance of a business in a fiscal year. Depending on the statements’ purpose, they can be prepared annually, quarterly, or monthly. The most common documents are the following:
Balance sheet
A balance sheet is a financial statement that presents the assets and liabilities of a business as well as its net worth. It also reveals the financial position of a company at a specific point in time. The balance sheet has three components: assets, liabilities, and net worth or equity. At the top of a balance sheet, you’ll find the company name and address, followed by the name and signature of an official from the company. Presenting the information in a few lines on a single sheet of paper makes it easier for users to read. Being one of the essential financial statements, a balance sheet provides a complete overview of the financial position of a business.
Cash flow statement
A cash flow statement tracks the movement of cash (in and out) within a business and provides an overview of a company’s cash flows based on its operations. This statement is used by corporations with significant assets for investment since it provides an accurate projection of the cash needed for asset purchases. On the other hand, businesses with fewer assets and short-term liabilities in the form of accounts payable or short-term debt use the income statement as their form of financial analysis. The cash flow statement also includes all areas where the company earned money, such as operations, investing and finance activities.
The bottom line is that the cash flow statement records cash inflows and outflows related to business operations. The information it provides helps management understand the company’s financial condition, assets, liabilities, and profitability. The cash flow statement consists of three main parts, namely:
- Operating activities– This is the first part, which analyses cash flows from net income or losses. It highlights the cash inflows and outflows related to the company’s business operations. It reconciles the net income to the actual cash received or used in operating activities.
- Investing activities– Here, you’ll find a list of cash inflows and outflows related to purchasing an investment property. Receipts from securities, forex and stocks are also included. The company’s investments and their movement should be followed closely.
- Financing activities– A business may secure capital by selling bonds and share capital. The cash flow statement includes loans, creditor’s advances, issues of debt securities and dividends paid to owners.
Income statement
The income statement discloses the revenues and expenses of a business in a given accounting period; it indicates and summarises the earnings, fees, and profit or loss of a business. It offers an overview of the main components of a company’s total annual revenues, including sales revenue and expenses. The information collected on the income statement is derived from tracking the business’s trading activities.
Statement of cash flows
This statement details the movement of cash within a company. It sets out the sources and uses of cash, investments in working capital, and earned income during the accounting period. The flow of money from operations, investing activities, and interest payments are presented separately in this financial statement to provide an accurate projection for inflows and outflows for all major areas where the company receives or pays out money.
Statement of Equity
This statement reveals the stockholder’s equity at a specific point in time. It is composed of two parts: capital and reserves. Capital consists of both common and preferred stock; it relates to the initial investment by the company’s owners. In addition, it also shows cash inflows from net income and capital gains for common stockholders, as well as dividends paid for preferred stockholders.
The statement of Equity also shows changes in the equity of a business over a specific period. Senior managers are provided with up-to-date information on the company’s equity, debts, and interest rates to make an informed decision as to if and when a dividend should be paid. The formula for changes to shareholder equity will vary from company to company; in general, there are a couple of components:
- Beginning equity: This is the initial amount of shareholder equity at the beginning of the year, which is determined by the number of shares outstanding.
- (+) Net income: Any income received from dividends, interest and other payments is added to the beginning equity.
- (-) Dividends: Dividends are subtracted from the beginning equity since they represent a return on investment.
- (+) Changes in working capital: Changes in the company’s inventory and accounts receivable are added to the beginning equity account.
- (+/-) Other comprehensive income: The company’s comprehensive income changes are added to the beginning equity.
How do financial managers utilise financial statements?
Financial statements have a significant impact on how financial managers administer their organisations. These tools provide a systematic and effective way for them to make strategic decisions. The reports are used to evaluate an organisation’s performance and financial condition, assist in decision-making and take advantage of opportunities. Here are some ways financial statements help financial managers:
- Determine budgets
Accounting and financial statements are used to help determine the company’s annual budgets. When financial managers prepare budgets, they use key components from the balance sheet and the income statement. The primary objective of budgeting is to transform the financial statement data into a budget-planning tool for measuring performance against goals. Budgets can be developed by various means, including statistical reports, pattern analysis, and consistent measures. Financial statements also help managers forecast revenues and expenses for a specific period. For example, a sales budget must be created before preparing an actual sales forecast.
- Evaluate performance
The financial statements provide a comprehensive snapshot of an organisation’s performance. As a critical concept financial managers require, performance evaluation is essential in determining the effectiveness of a current plan or achieving an objective. They use the data to measure and compare year-to-year results. This allows them to measure the impact of strategic decisions on performance, which helps them make better decisions about the future. After evaluation, the information can help managers take advantage of opportunities, adapt to changes in the environment, and correct weaknesses. The financial data can also help them make necessary adjustments, plan for contingencies, and set new goals.
- Align across departments
Many organisations are diversified, with sales, marketing, and research departments, among others, which help in the generation of revenue or improvement in sales. To run smoothly, these departments must be aligned. Financial managers are responsible for monitoring results, establishing goals and budgets, solving problems, being aware of internal and external issues, and ensuring departments communicate effectively.
The data from financial statements can present a holistic view of a company’s performance. For instance, the human resources department can use net income information when creating staffing plans and other budgets. The accounts payable team will use data from the balance sheet to assess whether they should issue purchase orders.
- Measure impact
Financial managers can use financial statements to measure the impact of their organisation’s operations on the market and its customers. The financial statements can be used to discover causes of trends, determine if actions have been effective, and measure the effectiveness of initiatives. They also provide information on how the company makes the money detailed in its income statement, balance sheet, and cash flow statement. With this information, they can make decisions differently than when unaware of these numbers.
- Think big-picture
Financial managers must understand the business environment and industry trends, including market demands and industry competition. Financial statements provide a comprehensive view of the company’s performance and ability to generate profit. The information contained in financial statements can be used to analyse, evaluate, and adapt in the face of change. The data is used to devise strategies to help the company perform better than its competitors.
Detailed information from financial statements provides a big-picture view to help create strategies, build budgets, recognise business opportunities and threats, and explain results to stakeholders.
- Drive team motivation
Motivation is one of the keys to a successful organisation. Financial statements give all employees an understanding of their organisation’s performance. Financial managers can use this information to help teams by pointing out positive results and identifying areas for improvement. Employees will be motivated to contribute to the organisation’s success and can also improve their effectiveness by pulling together departments to increase productivity.
- Cut unnecessary costs
Financial statements provide information about a company’s expenses, allowing financial managers to assess the organisation’s operations, identify areas of cost savings, and improve efficiency. By analysing data, they can identify potential opportunities to reduce costs. They can then advise senior managers on ways that profits can be maximised. That can be done by assessing and reducing labour costs if necessary, reviewing product and service prices, production costs, administrative expenses, advertising costs, etc. The annual budgeting process is used to determine which specific areas might need to be cut and how that should be addressed before any actions are taken.
Final thoughts
Financial managers are responsible for developing strategies and making decisions to maximise profitability and organisational efficiency. These goals can be achieved when they have a thorough knowledge of the four financial statements, understand how each statement works individually and collectively, and have an awareness of the current business environment.
An MSc in Finance will help you develop a broad knowledge of the financial services industry. With an in-depth understanding of finance and accounting and the ability to think analytically, you will be primed for an exciting career.