Financial statements (or financial reports) are a record of a business' financial flows and levels.
Typically they will include:
- a balance sheet setting out the net asset position of a business
- an income statement, income and expenditure statement or profit and loss account
- a cash flow statement
- a statement of other recognised gains and losses or other comprehensive income statement setting out movements in equity that do not go through the income statement or profit and loss account (eg a revaluation of the value of head office of a manufacturing company)
- statement of retained earnings
- supplementary notes and management discussion
Today most governments require publicly-traded companies to issue, and issue in a certain way, annual financial statements. Some governments, such as the United Kingdom government, require all companies to publish annual financial statements, although smaller companies only need publish them in abbreviated form.
History
Financial statements and records have been produced for as far back as there has been human writing. The people in the old Mesopotamian societies operated both insurance and credit (see interest) corporations, and had the obvious need of record keeping.
Financial condition
Each statement presents financial data relating to a company's or a group's current financial health, business results for the previous period, and other indicators that are used by the company's stakeholders to assess the health of a company. Typically a company's stakeholders will include existing and prospective shareholders, employees and trades unions, the taxation authorities, banks, suppliers and customers.
In most territories there is a requirement that financial statements are prepared using specific rules called generally accepted accounting practice or GAAP. Usually the requirement comes down to preparing financial statements that are true and fair. This has not always been the case in the past: for instance, in the UK the requirement used to be true and correct.
Each territory has developed its own local GAAP over time, making international comparisons of companies difficult. Recently there has been a push towards standardising GAAPs made by the International Accounting Standards Board ("IASB"). International GAAP has been adopted by Australia and the European Union (for publicly-quoted companies only), and is under consideration in South Africa. The United States Federal Accounting Standards Board has committed itself together with the IASB to converge the different GAAPs over time.
Promotion
To entice new investors, most public companies assemble their financial statements on fine paper with pleasing graphics and photos, attempting to capture the excitement and culture of the organisation in a "marketing brochure" of sorts.
Audit
Although the rules differ between jurisdictions, usually larger companies, and all publicly-quoted companies must have their financial statements independently audited. Note that the auditors do not certify financial statements, that is done by the company's directors. All an auditor does is examine the financial statements and records of a company and opines on whether they do indeed show a "true and fair" view (or meet other particular requirements that the auditor is engaged to opine on).
There has been much legal debate over who an auditor is liable to. Since audit reports tend to be addressed to the current shareholders, there is little doubt that they owe a legal duty of care to them. In the UK, they have been held liable to potential investors when the auditor was aware of the potential investor and how they would use the information in the financial statements. Nowadays auditors tend to include in their report liability restricting language, discouraging anyone other than the addressees of their report from relying on it. Liability is an important issue: in the UK, for example, auditors have unlimited liability.
System
Financial statements can also be representations of business structures as recorded in a double-entry book-keeping system, and are used to support internal record-keeping and decision-making. While businesses are not obligated to use this format internally, most do keep its basic structure because it is well-understood by employees and well-supported by information systems. In this format, businesses view their financial condition in terms of assets, liabilities, and equity. Transactions consist of debits and credits.