Financial Statements: Importance and Effect

Introduction

In the business world, effective financial management practices foster the decision-making processes concerning financial performance. In this regard, understanding the meaning of different financial statements goes a long way in facilitating the financial sustainability of the company, thus boosting its competitiveness (Healy & Palepu, 2012). Therefore, this paper looks at the various financial statements by assessing their importance and influence on business decision-making processes.

Consolidated Statement of Earnings

The Consolidated Statement of Earnings also referred to as the income statement constitutes one of the financial statements that provide information concerning the financial position of a particular company. The Consolidated Statement of Earnings depicts a firm’s revenues and expenses over a given period in a manner that makes one understand the process of transforming revenues into net income. Thus, by looking at the Consolidated Statement of Earnings, one knows whether the company attained profit or loss within a specified period (Ormiston & Fraser, 2013).

Importance of the Consolidated Statement of Earnings

The Consolidated Statement of Earnings assists investors and creditors in determining the organization’s preceding financial performance. As such, the investors may decide whether to inject their capital into the firm or not while the creditors weigh the possibility of reclaiming their credit facilities after lending the company. Additionally, the income statements facilitate the prediction of future performance besides evaluating the capacity of creating future cash flows over the income and expenses reports (Ormiston & Fraser, 2013).

Decisions Made Using the Income Statement

The statement of operations serves as a vital tool that aids managers in planning to foresee the extent to which chief business decisions implicate the earnings. Further, the income statement assists budget analysts in cutting costs associated with inefficient and cost-intensive business processes. In strategic decision-making, the income statement enables senior management to divest nonperforming units. Moreover, the income statement helps the management in making decisions that bolster the firm’s market share by analyzing the marketing tactics of a company’s competitors (Healy & Palepu, 2012).

The Balance Sheet

The balance sheet is an important financial statement that provides information about a firm’s liabilities, assets, and shareholders’ equity over a given timeline in the form of a summary. By looking at the balance sheet, one gets an understanding of the assets owned by the firm, what it owes, and/or the value of capital injected by shareholders (Ormiston & Fraser, 2013). In this regard, these financial statements ensure that the liabilities and capital are equal to the assets of the business.

Importance of the Balance Sheet

The balance sheet performs the crucial function of depicting the financial health or stands of the company in a given time. Additionally, the balance sheet informs the concerned parties whether the business owes more money than its current assets, thereby revealing the financial position of the firm. Moreover, besides portraying the value of its current assets, the balance sheet demonstrates the overall value of the business. Furthermore, a balance sheet that depicts a healthy financial position of a particular company enhances its chances of securing credit facilities and attracting investors (Ormiston & Fraser, 2013).

Decisions Made Using the Balance Sheet

As mentioned earlier, the balance sheet assists creditors in deciding whether to extend the limit of credit facilities to a given company by analyzing the profits and losses over a specified period. Further, the balance sheet helps decision-makers to determine the expenses that require cutting to curb loss-making. Additionally, it assists in making liquidation decisions in scenarios where the necessity of paying off the business debts using the assets available heightens. Moreover, the document fosters investment decisions given that one may invest in a business that depicts positive cash flows, profitability, and fewer liabilities (Healy & Palepu, 2012).

Statement of Cash Flows

As one of the chief financial statements, the cash flow statement provides information regarding the cash created and utilized during the time interval stated in the heading. Thus, the statement facilitates an assessment of the income acquired from operating processes to the firm’s net income. Further, the statement tells the variance in income effect and balance sheet accounts by summarizing the analysis in investing, operating, and financing undertakings (Ormiston & Fraser, 2013).

Decisions Made Using the Statement of Cash Flows

The statement of cash flows plays a significant role in facilitating financial decisions on the company’s growth. In this regard, the cash flows assist in determining the right decisions for financing the growth of a corporation, owing to how the money moves out and into the company. The move may entail dividend and debt reduction, buying its stock back, or engaging in acquisitions. Moreover, creditors and lenders use the statement to evaluate the company’s capability to repay (Healy & Palepu, 2012).

Information that Facilitates Decision-Making in the Statement of Cash Flows

The information that depicts the receipt of the equity instruments can foster the formulation of financial decisions associated with growth, owing to the capital injections gained over a given period. Further, the information regarding payment to suppliers for particular goods and services enables lenders and creditors to evaluate the relationship the company has with its suppliers (Ormiston & Fraser, 2013).

Unavailable Information in the Statement of Cash Flows to Assist in Managerial Decisions

The statement of cash flows lacks information that reflects the firm’s earnings, thereby undermining the development of timely decisions for financial management. Since the cash flows statement depends on past information, it fails to facilitate decisions that can improve future cash flows (Healy & Palepu, 2012).

Conclusion

The statement of operations, balance sheet, and statement of cash flows are chief financial statements. Individual financial statements play important roles in managerial decision-making. Hence, they foster the effectiveness of a firm’s financial management.

References

Healy, P., & Palepu, K. (2012). Business Analysis Valuation: Using Financial Statements. Boston, Massachusetts: Upper Saddle River, New Jersey: Cengage Learning.

Ormiston, A., & Fraser, L. (2013). Understanding financial statements. New York, NY: Pearson Education.

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