Financial statement

In finance and accounting, financial statements (or financial reports) are formal records of the financial activities and position of a business, person, or other entity.

Relevant financial information is presented in a structured manner and in a form which is easy to understand. They typically include four basic financial statements^[1][2] accompanied by a management discussion and analysis:^[3]

1. A balance sheet reports on a company's assets, liabilities, and owners' equity at a given point in time.
2. An income statement reports on a company's income, expenses, and profits over a stated period. A profit and loss statement provides information on the operation of the enterprise. These include sales and the various expenses incurred during the stated period.
3. A statement of changes in equity reports on the changes in equity of the company over a stated period.
4. A cash flow statement reports on a company's cash flow activities, particularly its operating, investing, and financing activities over a stated period.

Notably, a balance sheet represents a snapshot in time, whereas the income statement, the statement of changes in equity, and the cash flow statement each represent activities over an accounting period. By understanding the key functional statements within the balance sheet, business owners and financial professionals can make informed decisions that drive growth and stability.

"The objective of financial statements is to provide information about the financial position, performance and changes in financial position of an enterprise that is useful to a wide range of users in making economic decisions." Financial statements should be understandable, relevant, reliable and comparable. Reported assets, liabilities, equity, income and expenses are directly related to an organization's financial position. Two main purposes of annual financial statements are commonly distinguished: a payout-determination function, under which the statements serve as the basis for tax payments and distributions to owners, and an information function towards stakeholders such as shareholders, management, creditors, employees, customers, suppliers and competitors.^[4] Although such statements do not give users a direct measure of how far their individual objectives are being achieved, they provide objective information about the reporting period that allows users to make their own assessments, and they are considerably better protected against manipulation than forward-looking calculations.^[5]

In Germany, for example, the net income shown in the income statement of a stock corporation is adjusted for profit or loss carried forward and for transfers to or from revenue reserves in order to determine the distributable profit on which the dividend is based.^[6]

Because of the strong emphasis on creditor protection in German accounting law, profit is determined under the prudence principle, and both commercial and company law contain restrictions on distributions intended to preserve a minimum level of the company's assets for its creditors.^[7] By contrast, financial statements prepared under IFRS, which reflect the Anglo-Saxon tradition of capital-market financing, serve solely an information function; creditor-protection rules such as limits on distributable profit are not part of IFRS.^[8] In Germany, the separate financial statements of an individual legal entity prepared under the German Commercial Code (HGB) are intended to serve both the payout-determination and the information function, whereas consolidated financial statements serve solely an information function, because the group result is the basis for neither distributions nor taxation; the German legislator therefore limited the application of IFRS to consolidated financial statements.^[9]

For tax purposes, the sole addressee of the tax balance sheet is the tax authority, which uses the profit shown in it to determine income tax or corporate income tax as well as trade tax.^[10] Under Section 5(1) of the German Income Tax Act (EStG), the tax balance sheet follows the commercial-law principles of proper accounting unless tax law expressly requires otherwise; this link is known as the authoritative principle (Maßgeblichkeitsprinzip). Deviating tax rules exist mainly where commercial law leaves room for discretion that could be used to reduce taxable profit, or where significant fiscal interests are affected.^[11] For example, tax law prohibits provisions for expected losses from executory contracts, which are required under commercial law (Section 5(4a) EStG).^[12]

Financial statements are intended to be understandable by readers who have "a reasonable knowledge of business and economic activities and accounting and who are willing to study the information diligently."^[13] Financial statements may be used for different purposes:

• Owners and managers require financial statements to make important business decisions that affect its continued operations. Financial analysis is then performed on these statements to provide management with a more detailed understanding of the figures. These statements are also used as part of management's annual report to the stockholders.
• Employees also need these reports in making collective bargaining agreements (CBA) with the management, in the case of labor unions or for individuals in discussing their compensation, promotion and rankings.
• Prospective investors make use of financial statements to assess the viability of investing in a business. Financial analyses are often used by investors and are prepared by professionals (financial analysts), thus providing them with the basis for making investment decisions.
• Financial institutions (banks and other lending companies) use them to decide whether to grant a company with fresh working capital or extend debt securities (such as a long-term bank loan or debentures) to finance expansion and other significant expenditures.
• Stockholders may from time to time request insight into how share capital is managed, which may be made available via financial statements (or stock statements), as it lies in the financial interest of shareowners in affirming that capital stock is handled viably and mindfully with duly care.^[14]

Consolidated financial statements are defined as "Financial statements of a group in which the assets, liabilities, equity, income, expenses and cash flows of the parent (company) and its subsidiaries are presented as those of a single economic entity", according to International Accounting Standard 27 "Consolidated and separate financial statements", and International Financial Reporting Standard 10 "Consolidated financial statements".^[15][16]

Under German commercial law, consolidated financial statements are intended to give a true and fair view of the net assets, financial position and results of operations of a group of legally independent companies, presented as if they were a single company (Section 297(2) and (3) HGB). Because the group is not a legal person and cannot itself hold rights or obligations, claims of shareholders and of the state continue to be based on the separate financial statements of the individual companies; unlike separate statements, consolidated statements are not formally adopted, and they supplement rather than replace the separate statements.^[17] In the United States, by contrast, consolidated statements generally replace the parent's separate statements, and there is a de facto, though not legally prescribed, link between group profit and dividends paid.^[18] Consolidated financial statements are also gaining a payment-determination role through the OECD's "Pillar Two" global minimum tax, implemented in the European Union by Directive (EU) 2022/2523, whose tax base is determined at group level.^[18]

Because the group is treated as a single economic entity, uniform recognition and measurement rules must be applied throughout the group. Where the financial statements of a subsidiary were prepared under different rules or methods, an adjusted statement (in German practice called Handelsbilanz II, "commercial balance sheet II") must be prepared for inclusion in the group accounts; it forms the starting point for all consolidation procedures (Sections 300 and 308 HGB; IFRS 10.19). Consolidation then eliminates intra-group relationships through capital consolidation, debt consolidation, elimination of intra-group profits, and consolidation of income and expenses.^[19]

Different countries have developed their own accounting principles over time, making international comparisons of companies difficult. To ensure uniformity and comparability between financial statements prepared by different companies, a set of guidelines and rules are used. Commonly referred to as Generally Accepted Accounting Principles (GAAP), these set of guidelines provide the basis in the preparation of financial statements, although many companies voluntarily disclose information beyond the scope of such requirements.^[20]

Recently there has been a push towards standardizing accounting rules made by the International Accounting Standards Board (IASB). IASB develops the International Financial Reporting Standards (IFRS) that have been adopted by Australia, Canada and the European Union (for publicly quoted companies only), are under consideration in South Africa and other countries. The United States Financial Accounting Standards Board has made a commitment to converge the U.S. GAAP and IFRS over time.

Beyond protecting individual investors, financial reporting regulation also aims to safeguard the functioning of capital markets as a whole. In the European Union, for example, the Transparency Directive was intended to give investors a sufficient basis for their investment decisions and to strengthen their confidence in the functioning of the capital market.^[21] Following the financial crisis of 2007–2008, financial market stability also became a regulatory concern: the EU established the European Systemic Risk Board to assess risks to the financial system as a whole (macro level) and the European System of Financial Supervision to supervise individual financial institutions (micro level).^[22]

Management discussion and analysis or MD&A is an integrated part of a company's annual financial statements. The purpose of the MD&A is to provide a narrative explanation, through the eyes of management, of how an entity has performed in the past, its financial condition, and its future prospects. In so doing, the MD&A attempt to provide investors with complete, fair, and balanced information to help them decide whether to invest or continue to invest in an entity.^[23]

The section contains a description of the year gone by and some of the key factors that influenced the business of the company in that year, as well as a fair and unbiased overview of the company's past, present, and future.

MD&A typically describes the corporation's liquidity position, capital resources,^[24] results of its operations, underlying causes of material changes in financial statement items (such as asset impairment and restructuring charges), events of unusual or infrequent nature (such as mergers and acquisitions or share buybacks), positive and negative trends, effects of inflation, domestic and international market risks,^[25] and significant uncertainties.

• Accountable Fundraising
• Corporate financial accounting
• Financial statement analysis
• Comprehensive annual financial report
• Model audit
• Earnings report

• Alexander, D., Britton, A., Jorissen, A., "International Financial Reporting and Analysis", Second Edition, 2005, ISBN 978-1-84480-201-2

• IFRS Foundation & International Accounting Standards Board
• Financial Accounting Standards Board (U.S.)
• UN/CEFACT
• Mańko, Rafał. "New legal framework for financial statements" (PDF). Library Briefing. Library of the European Parliament. Retrieved 6 June 2013.
• Fundamental Analysis: Notes To The Financial Statements by Investopedia.com