What are Financial Statements? How is it Important for a Business?

Effective financial management is crucial for the success and sustainability of any business. But how can a company’s leadership group, investors, and other stakeholders comprehend and analyse its finances? This is where financial statements come into the picture.

Financial statements provide a complete overview of a company's financial data. They offer valuable insights into its financial health and performance, allowing the management team and investors to make well-informed decisions.

It becomes necessary to delve deep into the intricacies of financial statements, exploring what is a financial statement, the types of financial statements, and how they can help various stakeholders involved in a business.

Financial statements are documents that reflect financial data and performance during a given period. They represent a formal record of an organisation's business activities and financial transactions. Investors, company board members, and other stakeholders rely on financial statements to assess the company’s financial strength and gain insights into its current and future success. Shareholders utilise these statements to evaluate the status of their investments in a business.

The financial statements for Indian businesses usually comprise three components – the balance sheet, the income statement, and the cash flow statement. Each serves a specific purpose in providing a comprehensive overview of the company's financial performance.

1. Balance Sheet

   A balance sheet discloses a company's assets, liabilities, and shareholders' equity. It is a glimpse into a company's financial position at a specific time period. In simpler words, a company’s balance sheet displays the residual amount after liquidating (selling) all its assets and settling debts. Lenders and investors rely on the balance sheet to evaluate the company's liquidity, solvency, and overall financial health.

2. Income Statement

   The income statement summarises a company's revenues and expenses during a specific period. It indicates whether the company has incurred a net loss or profit during an accounting period. Investors and stakeholders can analyse the company’s income statement to assess its ability to generate profits and manage working capital.

3. Cash Flow Statement

   A company’s cash flow statement tracks the inflow and outflow of cash during a specific period. It indicates how much cash flows into a business and how it is being used to generate profits. Positive cash flow indicates profits, whereas negative cash flow reflects losses. Business owners, financial analysts, and investors can analyse the cash flow statement to assess the company’s ability to generate sustained profits and maintain operational liquidity.

The importance of financial statements for Indian companies in many ways. Listed below are a few aspects that depict how these documents shape a company's strategic direction:

• Ensures Regulatory Compliance

  When it comes to global finances and Indian businesses, financial statements play a crucial role in complying with legal and regulatory requirements. They contribute to increased transparency and accountability, ensuring the company adheres to prescribed norms and guidelines. As per the Securities and Exchange Board of India (SEBI) guidelines, all listed companies must release annual financial statements on their websites.

• Facilitate Research and Financial Analysis

  The financial statements of companies facilitate research and financial analysis along with credit evaluation of an entity. Investors, lenders, and other stakeholders can analyse these statements to gauge a company’s profitability, liquidity, solvency, and overall financial performance to make well-informed investment or lending decisions.

  Furthermore, financial statements facilitate comparability among various companies using standardised accounting principles and can provide credit solutions. For example, investors can compare the balance sheets of different companies to analyse their financial standings and make informed investment decisions.

• Helps the Government in Policymaking

  Financial statements aid the government in formulating taxation and regulatory policies based on the companies’ operational and financial performances. Government authorities can assess and levy taxes on businesses according to their income and asset levels reflected in their financial statements.

• Calculation of Financial Ratios

  Financial ratios, such as the Price-to-Earnings (P/E) ratio, Earnings Per Share (EPS), Debt-to-Equity (D/E) ratio, etc., help financial analysts and investors accomplish a comprehensive picture of a company’s financial health. Financial statements contain several values, including annual profits, shareholders’ equity, etc., that are essential for calculating these ratios.

Financial statements are essential tools that provide valuable insights into a company’s financial health and global financial management. They facilitate research, analysis, and comparability among various companies and help investors and lenders make well-informed investment or lending decisions.

Financial statements also aid the government in formulating taxation and regulatory policies based on companies' operational and financial performances. Furthermore, by understanding the importance of financial statements, businesses can build a robust foundation for long-term growth and expansion.