Why Accounting Statements are Necessary for Investment Decision Making?

Financial statements are important for both business owners and also investors. The statements provide a lot of information about a business. Looking at financial statements of the company, a business can know about the profitability, debt load, and liquidity position of a company.

In this blog post, you will know about the elements of the financial statement. Also, you will learn about the benefits of looking at the financial statement when making business decisions.

Elements of Financial Statements

Financial statements of a company consist of an income statement, balance sheet, and cash flow statement. The statements are prepared by gathering information from the accounts maintained by the outsourced bookkeeping companies. Public companies also prepare statements of owners’ equity.

Income Statement

Income statement shows the income generated from the business. The financial statement shows the sales, operational expenses, cost of goods sold, administrative expenses, taxes, and other major revenues and expenses.

Looking at the income statement, you can know about how well the business has performed at a given time. Information from the income statement can be used to calculate profitability ratios. It will help investors to know whether the business is a viable business to invest based on profitability.

Balance Sheet

Balance sheet contains information about assets, liabilities, and capital invested in the business. It shows the funding structure of the company. Investors can know whether the business relies on debit or capital financing. This gives the investors an idea about the risk of the business from an investment point of view.

The balance sheet also provides a lot of important information such as debtors and accounts receivables. It shows the credit owed to vendors and also credit due from customers. In addition, investors can know about the inventory of the business.

Information from business sheets can also be used to calculate important financial ratios. The working capital that is calculated by deducting current liabilities from current assets reflects the ability of the company in paying debts. A negative working capital ratio reflects that the company is in financial trouble.

The balance sheet provides information about long term assets such as land and building as well as current assets such as cash, inventory, prepaid expenses, and accounts receivable. The financial statement also provides information about the equity, account payables, and short and long term debt. The information is important for investors as they can know about return on investment and operational efficiency of the business.

Statement of Owner’s Equity

Statement of owner’s equity shows the breakdown of the change in equity during a period. It reflects capital invested, profit, dividends or drawings of owners. The information is also important for a potential investor.

Cash Flow Statement

Cash flow statement is one of the most important elements of the financial statement. The statements reflect the cash flow position of the company. The business may be profitable but it may be facing financing difficulties due to negative cash flow. This could be due to high expenses or difficulty in accessing funds to meet short term financial obligations.

Investors can look at the cash flow statement to know if the business has sufficient cash to meet business expenses. The statements reflect major cash inflows and also outflows. In addition, it shows capital investment that is not shown in the income statement. Looking at the cash flow statement investors can know whether the business has sufficient cash to meet financial obligations.

Cash flow statement shows the cash inflow and outflow. It shows whether the business has enough funds to pay important expenses and other financial obligations. Investors can look at the cash flow position to know about inflow and outflow of cash from operating, financing, and investing activities of the business.

Statement of Equity

Public companies prepare statements of changes in equity. The financial statement shows the changes in retained earnings and equity of shareholders. This information can be helpful for investors to determine the change in equity structure over a time period.

A company with increasing retained earnings is more stable as compared to an increase in the shareholder value.

Importance of Financial Statements for Investors

Investors can determine the financial position of the company by looking at the financial statements. The information contained in the financial statements provide information about the profitability, operational efficiency, solvency, and liquidity position of a company.

The financial statements of different companies in an industry can be compared to know how well the business is performing as compared to others.

Investors can make sound financial decisions by looking at information in the financial statement. The statements reflect the position of the company during a period of time. It will help investors to know whether it is viable to invest in the company.

Financial statements are particularly important for shareholders of a company. It will help small shareholders who don’t take part in business decision making to know whether to retain or sell their shares in the company.

Conclusion

Businesses must meet various reporting requirements of US GAAP and IFRS when preparing financial statements. The statements provide important information regarding the business profitability, solvency, and liquidity position.

Financial statements allow investors whether the business is performing well. They can look at the past and present financial statements to predict the financial performance of the company in the near term. They can know whether investing in the business will result in positive return on investment.

Financial statements must be free of any errors so that it correctly guides investors in making the right business decision. Professional chartered public accountants (CPAs) make sure that the financials are prepared using generally accepted accounting standards.

Creditors can also look at the financial statements to know whether the company will be able to repay the debut. A high debt to asset ratio indicates the company has insufficient to pay back the loan.

Maxim Liberty has a team of highly experienced certified public accountants (CPAs). We can help you prepare financial statements that can help investors and creditors to gauge the financial position of your company. Contact us today by dialing (703) 957-6938.