Question

What are the primary financial statements? What is the purpose of financial statements and why is it important to understand them?

Answer 1

The following are considered to be primary financial statements.

a) Balance Sheet

b) Income Statement

c) Cashflow Statement

d) Statement of Shareholder's equity.

The purpose of financial statements is to provide its users the information required to make appropriate decisions. Users include investors, management, employees, creditors, financial institutions, government, general public. They are called stakeholders.

It is important to understand the financial statements because of the following

a) Potential investors decides whether to invest or not in the company based on the information provided in the financial statements.

b) Lenders decide to provide or not to provide loan based on creditworthiness of the company. This could be known by interpreting financial statements.

c) Government can impose tax on the basis of profit earned by the company. Therefore, whether or not the calculation of profit is correct can be known by understanding the financial statements.

d) Employees need to understand financial statements because their livelihood is dependant on the company. They need to know whether they are being compensated accordingly or not.

Likewise, there are many more reasons which requires one to understand the financial statements.