Critically Assess the Uses and Limitations of Financial Statements
Critically assess the uses and limitations of financial statements
The definition for a financial statement is a written report which quantitatively describes the financial health of a company. (www.investorwords.com)
It consists of a balance sheet, income statements and a cash flow statement. This essay will critically asses the uses and limitations of each of these types of financial statements for a business.
A balance sheet shows the financial condition of a business at a specific date (Langemeier & Klinefelter 2008). It shows what is owned by the business, what is owed and the owner’s share (net worth) of the business. The balance sheet has three main uses. Firstly, it is used for reporting purposes as part of a limited company’s annual accounts. These must be shown to Companies House, HM Revenue and Customs and any shareholders unless agreed otherwise. It is also used to let potential investor’s or lenders asses the worth of a business at any given time. This way they can judge whether they think they should be investing money into the business according to how solvent the business is, how liquid its assets are, how the business is financed and how much capital is being used. Finally they can be used by the business itself to analyse how to improve its management.
There are a few limitations of a balance sheet as some values of current assets are estimated (www.businesslink.gov.uk); therefore the balance sheet does not reflect a 100% accurate financial position of a business. Also, the fixed assets in the balance sheet have taken the depreciation of the asset into consideration and so the true value is not shown. Finally, intangible assets such as goodwill cannot be measured and are therefore estimated figures too and may be very inaccurate thus causing the whole balance sheet to be incorrect. Therefore a balance sheet is useful in many ways as long as whoever is interpreting the figures takes into consideration that a few of the figures are not
The definition for a financial statement is a written report which quantitatively describes the financial health of a company. (www.investorwords.com)
It consists of a balance sheet, income statements and a cash flow statement. This essay will critically asses the uses and limitations of each of these types of financial statements for a business.
A balance sheet shows the financial condition of a business at a specific date (Langemeier & Klinefelter 2008). It shows what is owned by the business, what is owed and the owner’s share (net worth) of the business. The balance sheet has three main uses. Firstly, it is used for reporting purposes as part of a limited company’s annual accounts. These must be shown to Companies House, HM Revenue and Customs and any shareholders unless agreed otherwise. It is also used to let potential investor’s or lenders asses the worth of a business at any given time. This way they can judge whether they think they should be investing money into the business according to how solvent the business is, how liquid its assets are, how the business is financed and how much capital is being used. Finally they can be used by the business itself to analyse how to improve its management.
There are a few limitations of a balance sheet as some values of current assets are estimated (www.businesslink.gov.uk); therefore the balance sheet does not reflect a 100% accurate financial position of a business. Also, the fixed assets in the balance sheet have taken the depreciation of the asset into consideration and so the true value is not shown. Finally, intangible assets such as goodwill cannot be measured and are therefore estimated figures too and may be very inaccurate thus causing the whole balance sheet to be incorrect. Therefore a balance sheet is useful in many ways as long as whoever is interpreting the figures takes into consideration that a few of the figures are not
Bibliography: http://www.businesslink.gov.uk/ - Balance sheet, the basics (viewed 23/10/2010) Julie Hertenstein, and Sharon McKinnon. “Solving the Puzzle of the Cash Flow Statement.” Article 26: 160-167 http://www.investorwords.com/ Financial statement definition (viewed 23/10/10) Larry N. Langemeier and Danny Klinefelter - Balance Sheet, A Financial Management Tool , 2008, Published by AgriLife Extention, Texas A&M System http://www.money-zine.com/ Analysing Income Statements (viewed 24/10/2010) Harsha Yadalam, http://www.articlesbase.com – Limitations of Financial Statements, Jun 18, 2010