In the previous blog, Framework for Financial Statements: Meaning & Purpose, we learned that financial statements are not prepared randomly. They follow a proper structure laid down by the Framework for the Preparation and Presentation of Financial Statements. This framework ensures that financial information is meaningful, reliable, and useful for decision-making.
Now let us go one step deeper. Once the framework is in place, what exactly makes up a financial statement? And who actually uses these statements? That is what this blog is all about.
Understanding the components of financial statements and the people who use them helps us see why accounting is not just about numbers, but about communicating financial reality.
What are Financial Statements?
Financial statements are structured reports that show the financial health and performance of a business. They tell us:
- What the business owns
- What it owes
- How much profit or loss it made
- How cash moved in and out
These statements are prepared according to the framework discussed in previous blog, which gives them consistency and reliability.
Main Components of Financial Statements
According to the accounting framework, a complete set of financial statements normally includes:
- Balance Sheet
- Statement of Profit and Loss
- Cash Flow Statement
- Notes and Other Disclosures
Each of these plays a different role, but all are connected.
1. Balance Sheet
The Balance Sheet shows the financial position of a business at a particular date. It tells us:
- What the business owns (Assets)
- What it owes (Liabilities)
- What belongs to the owners (Equity)
In simple words, it answers:
“How strong is this business financially right now?”
For example, if a company owns buildings, machinery, cash, and receivables, all of these appear as assets. Loans, suppliers’ dues, and other obligations appear as liabilities. The remaining balance is the owners’ equity.
The balance sheet helps in judging:
- Liquidity (ability to pay short-term bills)
- Solvency (ability to survive long term)
2. Statement of Profit and Loss
This statement shows the performance of the business over a period. It tells us:
- How much the business earned (Income)
- How much it spent (Expenses)
- Whether it made profit or loss
If income is more than expenses, the business is profitable. If expenses are more, it shows a loss.
This statement helps users understand:
- Profitability
- Efficiency
- Cost control
It is very useful for investors and management to evaluate how well the business is doing.
3. Cash Flow Statement
Profit does not always mean cash. A business can show profit but still face cash shortage. That is why the Cash Flow Statement is so important.
It shows:
- How cash was generated
- How cash was used
It is divided into:
- Operating activities
- Investing activities
- Financing activities
This statement helps in understanding:
- Whether the business can pay its bills
- Whether it can invest or repay loans
4. Notes and Other Disclosures
Numbers alone do not tell the full story. Notes explain what the numbers actually mean.
They include:
- Accounting policies
- Details of assets and liabilities
- Related party transactions
- Earnings per share
- Segment information
These notes add transparency and help users understand the real picture behind the figures.
Who Uses Financial Statements?
Financial statements are prepared for many different users. Each user looks at the same statements but for different reasons.
1. Investors
Investors want to know:
- Is the company profitable?
- Is it safe to invest?
- Will it pay dividends?
They use financial statements to judge risk and return.
2. Employees
Employees are interested in:
- Stability of the company
- Growth prospects
- Ability to pay salaries and benefits
A financially strong company means job security.
3. Lenders
Banks and financial institutions use financial statements to check:
- Whether loans will be repaid
- Whether interest will be paid on time
They look closely at cash flows and liabilities.
4. Suppliers and Creditors
Suppliers want to know:
- Will the company pay for goods on time?
They focus on liquidity and short-term financial health.
5. Customers
Customers, especially long-term ones, want assurance that:
- The company will continue operations
- It can supply goods and services in future
6. Government
Government agencies use financial statements for:
- Tax assessment
- Regulation
- National income statistics
7. Public
The public looks at financial statements to understand:
- Company growth
- Employment generation
- Contribution to the economy
How Components and Users Are Linked
Each financial statement serves multiple users. For example:
- Investors use Profit & Loss for profitability
- Lenders use Cash Flow for repayment ability
- Government uses Balance Sheet for financial stability
All these are made possible because the framework discussed in previous article ensures the information is prepared in a consistent and fair way.
Conclusion
The components of financial statements are not just accounting formats. They are powerful tools that show the true financial story of a business. The users of financial statements rely on these reports to make important decisions — investing money, lending funds, offering jobs, or regulating businesses.
Frequently Asked Questions (FAQs)
1. What are the main components of financial statements?
The main components are the Balance Sheet, Statement of Profit and Loss, Cash Flow Statement, and Notes to Accounts.
2. Why is the Balance Sheet important?
The Balance Sheet shows what a business owns and owes at a particular date, helping users understand its financial position.
3. Who uses financial statements?
Financial statements are used by investors, employees, lenders, suppliers, customers, government, and the general public.
4. Why do investors study financial statements?
Investors use them to evaluate profitability, financial stability, and the potential return on their investment.
5. How does the Cash Flow Statement help lenders?
It shows whether a business generates enough cash to repay loans and interest on time.
6. What information is given in the Notes to Accounts?
Notes provide detailed explanations of figures in the financial statements, including accounting policies and additional disclosures.
7. How are financial statement components connected?
All statements are linked — profit affects equity, cash flow explains movement of money, and the balance sheet shows overall financial position.
8. Why are financial statements important for the government?
They help the government assess taxes, regulate businesses, and understand the economy.
