Secrets Behind Financial Statements You Should Know

Financial condition evaluation is a very important aspect of operating a company. Every company certainly wants to have healthy finances and be able to generate profits. To see the picture, financial statements become an important tool.

Financial statements can be used to check the company's financial health and performance that has been achieved in a certain period. It is important for not only large companies, but also medium and small enterprises to draw up financial statements.

Before preparing financial statements, an accountant must understand well what financial statements are, their functions, and various types of existing financial statements. Without adequate understanding, financial statements will not be accurate and unable to reflect the company's financial condition appropriately.

In this article, we will describe everything about financial statements, ranging from their definition, purpose of preparation, to various types of financial statements that need to be known.

What are financial statements?

Financial statement documents are formal records that record in detail the company's financial activities, including expenses, revenues, profits, and important changes in equity. According to the Indonesian Accounting Association (IAI), financial statements are an integral part of the financial reporting process.

Financial statements are often used to provide information to investors, company board members, and others about a company's current and future financial strength and performance. Investors and financial analysts rely on the financial data in the report to analyze the company's performance and make predictions regarding the direction of the company's stock price, financial health, and earnings potential.

Financial statements are also frequently audited by government agencies, accountants, firms, and others to ensure the accuracy of data and for tax, financing, or investment purposes. Annual reports that include a company's financial statements are one of the most important reliable and audited sources of financial data.

Companies are required to prepare their financial statements regularly in accordance with the guidelines and principles established by generally accepted accounting principles (GAAP) and international financial reporting standards (IFRS).

What is the purpose of preparing financial statements?

Financial statements have a number of significant benefits. One of them is to provide information to related parties regarding the company's financial strength and performance in a certain period.

A company's financial statements can provide an overview of a company's financial position, profitability, and growth potential. With financial statements, analysts can perform fundamental analysis to evaluate a stock's value and growth prospects.

In addition, financial statements can also be an indicator of danger signs related to financial instability or irregularities in accounting. Through financial statements, you can identify errors that may exist in the company that can interfere with financial health, as well as find the right solution to overcome these errors.

Financial statements are also useful in planning future financial actions. With financial statements, you can make estimates about expenses, income, investments, and financing that will be made in the future.

Are financial statements important for business?

There are several reasons why financial statements are very important for a business, including:

1.     Describe the Ability of a Business to Make Money:

Financial statements provide an overview of a business's ability to generate revenue and measure its profitability. This helps in evaluating financial performance and determining the extent to which the business is successful in achieving its financial goals.

2.     Identifying Profitability Issues:

Financial statements allow identifying profitability issues by tracking and calculating business expenses and revenues. By obtaining accurate data, management can identify factors affecting profitability and take appropriate measures to improve them.

3.     Assessing Debt Repayment Ability:

Financial statements help assess whether a business is able to pay back its debts. By looking at the balance between assets, liabilities, and equity, related parties can evaluate the adequacy of the financial resources owned by the company to meet its financial obligations.

4.     Investigating Business Transactions:

Financial statements provide detailed records of business transactions. This makes it possible to investigate specific transactions, identify unusual activity, and detect potential fraud or accounting errors.

5.     Supporting Informed Business Decision Making:

Financial statements provide information that is essential for informed business decision making. Accurate financial data helps management in evaluating business performance, planning strategies, allocating resources, and identifying opportunities or challenges that need to be faced.

6.     Describe Financial Relationships and Business Conditions: Financial statements reflect complex financial relationships and can provide an accurate picture of a business's financial condition. This information is useful to external stakeholders, such as investors, creditors, or business partners, who want to understand the health and sustainability of the business.

What are the benefits of preparing financial statements?

Financial statements show how the business operates. This report tells the company how much and how the business generates revenue and how much it costs to run the business, as well as what assets and liabilities the company has.

In addition, financial statements also show how efficiently a company manages its cash.

Financial statements provide detailed details about how well or poorly a company manages itself.

What are the types of financial statements?

Before making financial statements, you need to know in advance about the types of financial statements. The types of financial statements consist of income statements, statements of changes in capital, balance sheet statements, and cash flow statements.

1. Income Statements

The income statement is created to display the net profit or loss earned by the business during a certain period.

The income statement is different from the balance sheet statement, where the income statement covers a time span. The income statement coverage period is one year for annual financial statements and one quarter for quarterly financial statements.

The income statement provides an overview of revenue, expenses, net income, and earnings per share. The company calculates that profit or loss using the total value of the company's income and expenses.

Income

Revenue is everything that a company has sold or acquired for the goods and services they offer.

Revenue is divided into operating income, non-operating income, and miscellaneous income.

Operating income is income earned by selling a company's goods or services. The result of the company's core business activities is operating income.

While non-operating income is income obtained from non-core business activities or outside the main function of the business. Examples of non-operating income include: interest earned from cash in banks, income from strategic partnerships such as receipt of royalty payments, income from property rent, income from advertising on company properties, and others.

Income earned from other activities is referred to as miscellaneous income. Miscellaneous income can include profits from the sale of long-term assets such as land, vehicles, or subsidiaries.

Expense

An expense is anything a company has spent to produce their goods or services, including equipment, site rent, employee salaries, and so on. The expenses of a company are also commonly referred to as expenses.

The company's main expenses include cost of goods sold (COGS), sales, general and administrative expenses (SG&A), depreciation or amortization, and research and development (R&D).

Common expenses include employee wages, sales commissions, and utilities such as electricity and transportation. The interest paid on loans or debts is included in expenses related to secondary activities.

Losses incurred from the sale of assets are also recorded as expenses or expenses.

Companies can obtain informative reports on whether their overall revenue is positive or negative by subtracting expenses from revenue.

The main purpose of the income statement is to convey details of profitability and financial results of business activities. The income statement is very effective in showing whether sales or revenues have increased over several periods.

In addition, the income statement is also useful to help provide information for investors, both individuals and companies, about the success of the company and earnings per share (EPS) owned by shareholders.

EPS gives shareholders information about how much money they will receive for each share they own if the company wants to split all the revenue they earn.

Generally, a company or business more often refrains from splitting its revenue and does not reinvest in the company. However, the EPS value allows investors and shareholders to evaluate the company's performance and understand how they can benefit from it.

The presentation of the income statement is divided into two forms, namely:

A. Single Step Model

The single-step income statement does not group the statement on income and expenses into business groups and outside businesses. This form simply groups revenue and profit with loss costs.

This single-step income statement has a simple form and does not display the company's financial turnover in detail.

The calculation formula used in the single-step income statement is:

Net income = (Revenue + Profit) – (Expense + Loss)

B. Multiple Step Model

In the form of a multistep model, reports are divided into groups based on revenues and costs arranged in a certain order.

The multiple step income statement breaks down each income and expense by business operations unrelated to its activities.

There are three different formulas for the multiple step income statement model:

1.     Gross profit = Net Sales – Cost of goods sold

2.     Operating income = Gross profit – Operating expenses

3.     Net income = Operating income + Non-operating items

2. Cash Flow Statements

A cash flow statement is a comprehensive financial document used to help determine a company's or business's performance over time and examine positive or negative fluctuations.

The cash flow statement uses information similar to the income statement and balance sheet statement to describe a company's bank balance and cash movements over a given period.

These statements generally take a while to be collected and reviewed, therefore generally cash flow statements are completed only when requested by outside sources, such as investors, potential buyers, or governments.

To calculate the cash flow statement there is no need for a formula, but there must be three parts that report cash flows for various activities that require the company to use its cash.

Three components in the cash flow statement, namely:

A. Operational activities

Operating activities are part of the cash flow statement that describes a company's cash flows from key business activities, including cash received from consumer purchases and cash spent on employees, suppliers, taxes, and others. These activities generally focus on the creation and sale of inventory, and company services.

B. Investment activity

The investment activity section focuses on all purchases and sales of assets outside of its inventory. This section may include equipment, technology, and other goods or facilities that directly affect the production of goods or services.

C. Financing activities

The financing activities section lists the actions of the company that contribute to the financing and operation of the business. This section can include selling stocks and bonds, as well as receiving loans from banks, or anything that adds to the company's spending ability or the expenses generated by the company will add to the company's share of financing activities.

3. Equity Change Report

The statement of changes in capital or equity refers to the shares purchased, dividends issued to investors, and the gains and losses the company as a whole suffered in the reporting period.

The statement of changes in equity is also referred to as the statement of retained earnings. The statement of changes in equity contains a reconciliation of the initial and final balances in the company's equity during the reporting period.

These financial statements are often created by companies for investors and shareholders because these reports do not contain much valuable information according to the management team or employees of the company.

The contents of this report are often obtained through information listed both on the balance sheet and income statement of the company.

The capital change report is developed from the balance sheet statement and provides additional information related to shareholders' equity during the reporting period.

The statement of changes in equity includes the following elements:

·      Net profit or loss

·      Dividend payments

·      Equity withdrawal

·      Effect of accounting policy

·      The effect of corrections in previous accounting periods

·      Accumulation of reserves and retained earnings

These financial statements begin with the initial equity balance, then add or subtract from profits and dividend payments which then result in the final balance. The amount of profit and loss in one period is also one of the important components in the statement of changes in equity, therefore before making this financial statement it is necessary to make an income statement first.

The calculation for the statement of changes in equity is carried out using the following formula:

Initial equity + Net income – Dividends ± Other changes = Ending equity

4. Balance Sheets

The company makes a balance sheet to describe whether assets have the same value as the amount of liabilities and equity of the company. This can help investors to understand that the company has a healthy balance of expenses and income that positively affects shareholders and investments.

The formula used to calculate the value of an asset is:

Assets = Liabilities + Equity

The balance sheet report is used by companies to discuss the financial position of the business at the time of making the report by listing three aspects, namely assets, liabilities, and company equity.

A. Assets

Everything owned by a company or business that has value is an asset. Assets are generally physical objects that can be sold or used by companies to create products and services for consumers. Technology, inventory, and production equipment are examples of assets commonly owned by companies.

Common assets are described by how quickly they can be converted into cash. For example, inventory might be listed first because the company expects to sell inventory within one year.

B. Liability

Liabilities or liabilities are the amount of money owed by a company to other individuals or organizations. Liabilities are often expenses that must be paid by the business in the future, including money given to suppliers, location rent, loan payments, and others.

Liabilities are recorded based on their due date. Liabilities are divided into present or long-term liabilities. Current liabilities are expected to be repaid within the current year and long-term liabilities are liabilities that will mature more than one more year.

Contingent liability is also important to companies because it is an expense that may have to be added in the future, including lawsuits and product warranty settlements.

C. Equity

Equity is the amount of money left over after a company sells assets and pays its liabilities or liabilities.

Shareholders' equity is listed as the amount invested by shareholders in a company after that company's losses or profits were taken into account from the start.

This money then belongs to the shareholders and owners of the company and is used to help determine how successful the business is, and how much money the company can give shareholders if the company goes out of business.

5. Notes to Financial Statements

Notes to financial statements or CALK are records that reveal detailed assumptions made by accountants that detail things that exist in other types of financial statements.

The CALK report aims to make the details of other report information easier to understand. Notes to the financial statements will describe the deviations that occur in the methodology used from year to year, so that appropriate solutions can be found for existing deviations.

CALK is generally located at the very back of the financial statements. CALK itself usually consists of many pages and is very thick.

However, CALK is not a mandatory report but only acts as a support if there are shareholders who need information to support the evidence of the report.

Therefore, CALK often lists the basic issues that plague a company's financial health.

How do I determine the type of financial statements to be used?

1. Understand the function and purpose of each report

By understanding in advance the basic principles of each type of report and the information they can reveal about your company, you can better prepare yourself for making financial statements.

For example, let's say you want to create a report for investors and don't know which type of report is the most informative. Income statements and statements of changes in equity are probably the most appropriate choices, although each financial statement provides investors with useful information.

2. Find out in advance for whom the report is made

The type of financial statements to be used is generally greatly influenced by who the reports are made for and what they want to know from the information.

For example, if a company wants to create financial statements for its management team to find and solve problems related to expenses, the best type of report for this company is the cash flow statement or income statement.

3. Organize information accurately

Before creating financial statements, it is important that you have all the necessary information to make an accurate representation of the company.

If you can't get all the information needed for financial statements, you can consider using a different variation. For example, if your company is just trying to create a cash flow statement for the first time, you may find it difficult to create a thorough document because it is meant to show fluctuations over a long period of time.

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