Summary
Summary Financial Management 214: Chapter 2: Financial statements
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In depth summary of Chapter 2 for financial management 214 which covers the financial statements.
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FinancialStatements
Introduction
According to the companies act (no. 71 of 2008), companies are required to publish a set of
annual financial statements compiled in accordance to IFRS. According to IFRS, the objective
of a company’s financial statements is to provide useful financial info to existing and
potential shareholders, lenders and creditors. Other stakeholders also benefit from this info.
These annual financial statements provide a summary of a company’s financial position,
financial performance and change in financial position over a certain period of time (usually
a year). The financial position of a company is influenced by the economic resources
available and the financial structure used to finance it. It is evaluated by focusing on assets,
liability and OE as indicated in the SoFP. Financial performance refers to the company’s
ability to generate revenue with available assets (determined by focusing on income and
expenses as seen in SOCI/SOPL). Changes in financial position depend on investment,
operating and financing activities during the year (seen in statement of cash flows).
Users of Financial Statements
The main objective of financial statements is to provide info to existing and potential equity
and debt capital providers and other stakeholders. Different aspects of financial
performance and position are important to different stakeholders.
Current and potential shareholders
They are interested in its ability to generate income/return and they use financial
statements to evaluate current and future financial performance. They are
interested in profit earned on investment, the health and sustainability of the
company and the cash distribution they receive on their investment in the form of
dividends or share purchases.
Current and potential providers of debt capital
Interested in the amount of debt capital in an enterprise’s capital structure relative
to equity provided by shareholders. The ability to meet capital and interest
repayments is also important.
Management
Management should continuously be informed to ensure efficient internal decision
making. Management uses financial statements to determine management
objectives and for planning and control.
Employees
Does the company earn sufficient profits to cover their salaries and wages? The
financial statements also contain info about their retirement benefits and medical
aid contributions. Info regarding the firm’s management compensation is also
included in the financial statements.
Government organizations
Tax calculations are based on financial statements. SARS requires annual financial
statements to determine if tax calculations are correct. It is also used for economic
statistics.
Diverse groups
, Examples include customers of the enterprise, providers of raw materials and
inventory, competitors, stockbrokers etc.
Requirements of Financial
Statements
UNDERSTANDABLE
Information should be reflected in a logical and comprehensible manner.
RELEVANT
The information in financial statements needs to be relevant to the requirements of users. It
should allow the user to evaluate the past, present and future changes that can affect the
company (users should be able to determine if previous evaluations were correct and if not,
to determine the necessary adjustments. Significance (if the exclusion or incorrect
measurement can have a significant effect on the decisions of users of fin statements) and
timeliness (info needs to be made available in the period where it affects users’ decisions)
are important.
RELIABLE
Info needs to be accurate and objective allowing users to obtain an accurate summary of
the financial position/performance of the company.
COMPARABLE
To ID the financial performance and situation of an enterprise, the financial statements
need to be comparable over time and with other companies. For financial analysis, it is NB
for financial statements to be standardized across companies. It also simplifies ratio
calculations.
Statement of Financial Position
Provides a summary of a company’s
financial position at a specific date
(usually the end of a company’s
financial year). The asset side gives
details about assets owned by the
company and the equity and liability
side gives info about the sources of
capital to fund assets. The
statement of financial position is a
summary of the sources of capital
obtained by the enterprise and the
application of capital. Current and
non-current assets (classification
based on lifetime) and liabilities
(classification based on maturity of
the items).
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