The Role of Financial Statements in an Effective Market

Topics: Income statement, Financial statements, Balance sheet Pages: 7 (2382 words) Published: January 31, 2010
Financial Statements

The Role of Financial Statements in an Effective Market:

Financial Statements are a company’s primary source of financial information. If you want to invest in a company and needed to know how to find out if a certain company is worth the investment you would take a look at the company’s financial statements. Simply put a financial statement is a declaration of what is believed to be true about a company, communicated in terms of a monetary unit, such as the dollar. The financial statements will show what are the sources of the company’s revenue and how is the money spent. What does the company own and what does it owe others? How much profit has the company made and what is the financial health of the organization?

Companies prepare balance sheets as a way of summarizing their financial positions at a given point in time. The other financial statements relate to the balance sheet and show how important aspects of a company’s financial position change over time. The balance sheet is a summary of an enterprises' assets, liabilities and equity at a specific moment of time. To simplify this description even further we could say that the balance sheet shows an entity's possessions, obligations and others' debts to it.

As we all know a fundamental characteristic of every balance sheet is that the total figure for assets always equals the total of liabilities plus owners' equity. As we have already seen, actually the above simple equation, representing the theoretical essence of this document, and a basis of its practical side, is the reason for it to be called balance.

To summarize in short the practical side of the balance sheet, no matter how often it is drawn, and what of the two popular forms it is presented in, the balance sheet, as known, consists of three major parts: assets - or what the firm possesses and has the right receive in future; liabilities - or what the firm's obligations are; shows also how many of these should be returned in the short-run, and how many the enterprise can employ in the long-run; owner's equity - the firm's capital, it can be also figured as the difference between assets and liabilities.

Some of the principles that can be referred to the balance sheet: The entity principle: as in all accounting documents in the balance sheet an enterprise is presumed to exist in its own right. It is therefore treated as a separate entity from the person or persons who own or operate it and in no way reflects their assets or liabilities. The same applies equally to organizations that are not commonly referred to as businesses. The cost principle: I would classify this one as may be the most contradictory principles not only in the financial statements but in the accounting itself. I can even add that it is the reason for some of the negative aspects of the balance sheet. In spite of the different ways in which assets can be valued the accountants have traditionally used the historic cost as the basis of valuation of assets in the balance sheet, assuming that the enterprise is a going-concern, and taking into consideration the need for objectivity.

We can use another contemporary definition of it given by A. Belkaouli in Accounting theory: The balance sheet measures the financial positions at a point in time. I think the arguments of the author are clear: if we assume that the current financial position can be described with the figures of the firms' possessions and obligations, listed by types and amounts than we would have to agree that the balance sheet gives us this information. Obviously, being an indicator of the enterprises' financial position, the balance sheet is a useful and powerful tool in the hands of managers, financial analysts and external users. Combined with the data on other financial statements it forms different ratios which are the basis of each financial analysis. It is this data that can tell you if a company has enough money to continue to fund...

Bibliography: Arnold J., and S. Turley, Accounting for Management Decisions, 3rd ed., 1996, Prentice Hall Europe (UK) Limited
London Berry A. and R. Jarvis, Accounting in a Business Context, 2edshnvd. ed., 1994, Chapman & Hall
London Watts J., Accounting in the Business Environment, 2nd ed., 1996, Pitman Publishing
London Adam, J.H., Longman Dictionary of Business English, 2nd ed., 1989, Longman Group UK Ltd.
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