What is the objective of general-purpose financial statements?
The objective of financial statements is to provide information about the
- financial position,
- financial performance and
- cash flows of an entity that is useful to a wide range of users in making economic decisions.
These users include existing and potential investors, lenders and other creditors.
Users of financial statements make economic decisions based on their evaluation of the ability of the entity to generate cash and cash equivalents and of the timing and certainty of their generation.
This ability ultimately determines, for example, the capacity of an entity to pay its employees and suppliers, meet interest payments, repay loans and make distributions to its owners.
Users are better able to evaluate this ability to generate cash and cash equivalents if they are provided with information that focuses on the financial position, financial performance and cash flows of an entity.
Information provided
General purpose financial statements provide information about the financial position of the entity which includes information about economic resources and the claims against them.
They also include any changes in its financial position which could be due to other factors such as financial performance or other issues like raising debt.
This allows users of the financial statements to identify the strengths and weaknesses of the entity, and also to assess the entity’s liquidity and solvency, plus any needs for additional financing.
Financial performance
Accrual accounting shows the effects of transactions and other events on an entity’s assets and liabilities in the periods in which those effects occur, even if the cash is received or paid in a different period.
This allows users to more relevant information regarding an entity’s financial performance than using a cash receipts basis.
Information provided by an entity’s financial performance allows users of the financial statements to assess:
- Management performance
- An entity’s ability to generate cash
- The risks associated with a business, and how they could affect the entity.
Cash flow management
Cash flow management is another important part of performance.
Under the accruals concept, transactions such as sales and purchases are recoded in the period they are incurred.
This doesn’t show us information about when the money is due to be received from customers, or paid to suppliers.
By reviewing cash flow information, users can assess the entity’s ability to generate cash inflows, and how it spends cash.
Cash is connected to the solvency of a company; a profitable company could be insolvent if it doesn’t have enough money to pay its debts.
This could happen if it gives more credit than it receives, and doesn’t have enough cash to bridge the difference.