Financial statements are essential documents that help investors and other stakeholders understand the financial health of a business. However, they can be overwhelming to those unfamiliar with them. This guide will provide an overview of financial statements and explain how to interpret them.

What are Financial Statements?

Financial statements are formal reports that present a company’s financial performance and position to its stakeholders. Typically, financial statements are comprised of five main components as per IAS 1:

• Statement of Financial Position

This statement provides a snapshot of a company’s financial position at the end of the reporting period. It includes assets, liabilities, and equity. Assets are economic resources the company controls and expect to derive future benefits from. Liabilities are obligations arising from past transactions or events, and equity represents the residual interest in the company’s assets after liabilities are deducted. Additionally, suppose the company applies an accounting policy retrospectively or makes a retrospective restatement of items in its financial statements or reclassifies items in its financial statements. In that case, it must also include information on the financial position at the beginning of the preceding comparative period.

• Statement of Profit and Loss and Other Comprehensive Income

This statement shows a company’s performance during the reporting period. It includes revenue, gains, expenses, and losses. Revenue is the inflow of economic resources from selling goods or services. Profits and losses arising from events outside the company’s primary operations, such as the sale of an asset or an impairment loss. Additionally, this statement may include other comprehensive income items of income and expense that are not recognised in profit or loss per IFRS Standards. IAS 1 allows an entity to present a single combined statement of profit and loss and other comprehensive income or two separate accounts.

• Statement of Changes in Equity

This statement shows the changes in a company’s equity during the reporting period. It includes transactions with owners, such as the issuance of shares, payment of dividends, and changes in reserves.

• Statement of Cash Flows

This statement provides information about a company’s cash inflows and outflows during the reporting period. It includes cash flows from operating, investing, and financing activities. Operating activities are the primary revenue-producing activities of the company while supporting activities involve acquiring or disposing of long-term assets. Financing activities include raising or repaying capital.

• Notes to the Financial Statements

Notes to the financial statements are a critical component of financial reporting that provide essential context and details about a company’s financial statements. These disclosures contain additional information about the financial statements, including a summary of significant accounting policies and other explanatory information. The summary of essential accounting policies explains the accounting methods and principles used to prepare financial statements. This information helps users of the financial statements better understand the basis on which the financial report was prepared and presented.

In addition, the notes to the financial statements may include information about any contingencies, commitments, or other events that could significantly impact the company’s financial performance or position. For example, the notes may disclose pending legal disputes, tax audits, or environmental liabilities. The notes may also provide details about any related party transactions, such as loans or sales between the company and its directors or major shareholders.

The notes to the financial statements are an important source of information for investors, creditors, and other stakeholders. They provide a more complete picture of a company’s financial position, performance, and risks. Users of the financial statements should carefully review the notes to better understand the company’s financial statements and make informed decisions based on this information.

Interpreting Financial Statements

To analyse financial statements, investors and other stakeholders can use various tools and ratios. These tools help to provide a more comprehensive understanding of a company’s financial performance and position. For instance, the liquidity ratio can be calculated by dividing current assets by current liabilities to determine a company’s ability to meet its short-term obligations. The debt-to-equity ratio can be calculated by dividing total liabilities by total equity to measure a company’s financial leverage. Other useful ratios include the return on equity ratio, which shows how much profit a company generates based on the amount of shareholder equity invested, and the gross profit margin ratio, which indicates a company’s ability to generate profits after accounting for the cost of goods sold. By analysing financial statements and using these ratios, investors and other stakeholders can gain valuable insights into a company’s financial health and make informed decisions.

Conclusion

Financial statements provide vital information about a company’s financial performance and position. By adhering to the components of financial statements as per IAS 1 and using appropriate analytical tools and ratios, investors and other stakeholders can gain valuable insights into a company’s operations and make informed decisions.