What are Financial Statements and Why They’re Important?

Have you ever found it challenging to keep your financial statements accurate and organized? Manual reporting is prone to errors, and even small mistakes can lead to inefficiencies, poor decisions, and potential financial setbacks.

That’s why using a reliable accounting system like HashMicro Accounting Software is essential. With advanced features, it ensures greater accuracy in your financial statements, reducing the risks that come with manual management.

In this article, we’ll discuss the role of financial statements and why they matter for businesses. You’ll also learn how precise financial reporting supports better decision-making and how modern accounting software simplifies the entire process.

What are Financial Statements?

Financial statements are documents prepared by businesses to summarize their financial performance and position. These reports are typically reviewed by government authorities and accountants to verify accuracy and support tax compliance, financing, and investment decisions.

For-profit companies primarily rely on four key financial statements: the balance sheet, income statement, statement of cash flows, and statement of changes in equity.

While nonprofit organizations also use financial statements, their versions have different names and convey slightly different details.

How Does a Financial Statement Work?

Financial statements can be prepared for various time periods. Annual financial statements summarize a company’s financial performance for its most recent fiscal year, while interim financial statements may be generated on a monthly, quarterly, or semi-annual basis.

Interim reports often contain fewer components than year-end statements. For instance, they might exclude the cash flow statement and the statement of retained earnings.

Philippine companies, especially those regulated by the Securities and Exchange Commission (SEC) and the Bureau of Internal Revenue (BIR), are required to submit annual financial statements following the Philippine Financial Reporting Standards (PFRS).

Publicly listed and larger companies also prepare quarterly financial statements, while some businesses may generate monthly or semi-annual reports for internal management purposes.

Why are Financial Statements Important?

Financial statements are essential for running and growing a business. They help with planning, budgeting, and tracking performance by comparing actual results with targets and forecasts.

So what is the importance, other than those mentioned above? Here’s how a business can use their financial statements for:

• If revenue increases but profit margins drop, the business may need to improve pricing or reduce costs. If expenses are higher than expected, cutting unnecessary spending might be necessary.
• Investors, lenders, and business partners rely on financial statements to understand a company’s financial health. A thorough review ensures that every detail is considered.
• Financial statements are also used for tax filings. Since tax rules differ from accounting standards, some reports include future income taxes.

Elements of a Financial Statement

Understanding the key components of a financial statement helps you get a clear picture of your company’s financial health. Below are the financial statement components.

1. Income Statement

An income statement outlines a business’s profitability by reporting its revenues, expenses, and net income over a given period. Also known as a profit and loss statement, it highlights the company’s financial performance.

It includes:

• Revenue from sales of products or services
• Expenses incurred to operate the business
• Net income (profit) after deducting all expenses
• Gains or losses from non-core activities

Example:
XYZ Café generated ₱500,000 in revenue in January. It incurred expenses, including rent, salaries, and supplies, totaling ₱350,000. After subtracting expenses, its net income for the month was:

• Revenue: ₱500,000
• Expenses: ₱350,000
• Net Income: ₱150,000

2. Statement of Retained Earnings

The statement of retained earnings shows the accumulated profits that a business has kept after distributing dividends to shareholders. It reflects changes in retained earnings from one period to the next.

If a company starts with ₱1,000,000 in retained earnings, earns ₱500,000 in profit, and distributes ₱200,000 in dividends, the retained earnings would be:

• Beginning Retained Earnings: ₱1,000,000
• Net Income: ₱500,000
• Dividends Paid: -₱200,000
• Ending Retained Earnings: ₱1,300,000

3. Notes to the Financial Statements

The notes to the financial statements provide additional details on the accounting principles, assumptions, and estimates used in preparing the financial reports. These notes help stakeholders interpret and analyze the financial data more effectively.

They typically include:

• Accounting policies and estimates applied in the financial statements
• Supplementary details for specific line items, such as:
  • A breakdown of accounts payable and receivable
  • Revenue distribution across different business segments
  • The amortization period for long-term assets
• Other key information, including:
  • Financial risks, such as foreign exchange fluctuations or credit concentration risks
  • Violations of loan agreements, if any
  • Contingent liabilities (potential obligations)
  • Details about acquisitions or strategic investments
  • Whether the financial statements were prepared using the cash basis or accrual basis accounting method

There are many components to get to know of and apply in the daily tasks, right? With the amount of information your company has, especially when it’s thousands of transactions and values that must be documented, it must be tiring to do it all manually.

So, why don’t you try automating the tasks by using a digital solution. Just let the software work for you, and you can have an easier time analyzing and checking the works. Click on the pricing scheme banner below to see the price!

3 Types of Financial Statement

The three key financial statements are (1) the income statement, (2) the balance sheet, and (3) the cash flow statement. Each one provides essential financial insights for both internal and external stakeholders.

1. Income Statement

The income statement is often the first document investors and analysts review, as it tracks the company’s performance over a specific period.

It starts with sales revenue, deducts the cost of goods sold (COGS) to calculate gross profit, and further adjusts for operating expenses and other income to determine net income—the company’s “bottom line.”

Key Features:

• Summarizes revenues and expenses over a set period (e.g., one year, one quarter).
• Uses accounting principles like accruals and matching, rather than a cash basis.
• Helps assess the profitability of a business.

It’s calculated by:

Assets = Liabilities + Shareholders’ Equity

Example (in Philippine Pesos):
A business, ABC Corporation, has ₱5,000,000 in assets, including cash, accounts receivable, and equipment. Its liabilities, such as loans and unpaid expenses, total ₱2,000,000. The remaining amount, ₱3,000,000, represents shareholders’ equity. The balance sheet would reflect:

• Assets: ₱5,000,000
• Liabilities: ₱2,000,000
• Shareholders’ Equity: ₱3,000,000

2. Balance Sheet

The balance sheet provides a snapshot of the company’s financial position at a specific point in time by listing its assets, liabilities, and shareholders’ equity. The total assets must equal liabilities plus equity, ensuring the balance sheet remains accurate.

It begins with cash and equivalents, matching the ending balance from the cash flow statement. The balance sheet also reflects changes in retained earnings, incorporating net income from the income statement and adjustments for dividends.

Key Features:

• Represents the financial position of a business.
• Displays data at a specific date (e.g., “as of December 31, 2017”).
• Divided into three sections: assets, liabilities, and shareholders’ equity.
• Maintains the equation: Assets = Liabilities + Shareholders’ Equity.

3. Cash Flow Statement

The cash flow statement starts with net income and adjusts for non-cash expenses. It then calculates cash inflows and outflows based on changes in the balance sheet.

This statement highlights how cash moves through the business over a specific period, showing the net change in cash, along with the beginning and ending cash balances.

Key Features:

• Tracks cash inflows and outflows over a set period (e.g., one year, one quarter).
• Adjusts for accrual accounting to reflect actual cash movements.
• Divided into three sections: cash from operations, cash used in investing, and cash from financing.
• Displays the net change in cash balance from the start to the end of the period.

Example:
DEF Manufacturing had the following cash transactions in Q1 2024:

• Operating Cash Inflows: ₱1,200,000
• Operating Cash Outflows: ₱900,000
• Net Cash from Operations: ₱300,000
• Investment in Equipment: -₱150,000
• Loan Received: ₱200,000
• Cash Flow for the Period: ₱350,000

Who Needs Financial Statements and Reports?

The need to provide financial documents depends on who requires them and for what purpose. Financial statements and related reports may be necessary for:

• Lenders and financing partners
• Private and angel investors
• Bonding and insurance companies
• Regulatory agencies and tax authorities
• Credit rating agencies
• Suppliers
• Unions
• Investment analysts

In some cases, businesses must submit both year-end financial statements and interim reports (monthly, quarterly, or semi-annual).

These may include an interim balance sheet, income statement, aged receivables and payables report, and margin report to provide a clearer financial picture.

Limitations of Financial Statement

While financial statements provide valuable insights into a company’s performance, they have certain limitations. Interpretations can vary, leading investors to different conclusions about a company’s financial health.

• Some investors may prefer stock repurchases, while others might favor reinvesting in long-term assets.
• A company’s debt level may seem acceptable to one investor but concerning to another.
• Comparing financial statements over multiple periods helps identify trends and assess the company’s performance relative to industry peers.
• The reliability of financial statements depends on the accuracy of the data provided. Fraudulent activities or poor oversight can result in misleading reports, even if the statements are audited.

Despite these limitations, financial statements remain a critical tool, though users must exercise caution and trust in their accuracy.

Simplify Financial Statements Management with HashMicro Accounting Software

Keeping your financial records in order can be overwhelming. From tracking income and expenses to preparing financial statements, manual processes take too much time. And when numbers don’t add up, it leads to delays and lost time to record everything.

That’s why businesses are turning to HashMicro’s Accounting Software. It automates financial reporting, eliminates errors, and gives you real-time insights into your business performance. It’s equipped with these features that help you with financial statements:

• Multi-Level Analytics: Break down your financial statements by branch, project, or division. You can switch views and compare financial performance across different segments.
• Financial Statement with Budget Comparison: See your actual numbers side by side with your budgeted figures.
• Profit & Loss vs. Budget & Forecast: Line up your profit and loss statement with your budget and forecasts to see how projections compare to reality.
• Cash Flow Reports & Forecast Budget: Monitor money coming in and going out with detailed cash flow reports. Plus, you can use predictive tools to forecast future cash needs.
• Financial Ratio (Automated Calculation): Instantly generate key financial ratios like liquidity, profitability, and debt levels without manual calculations.

Conclusion 

Financial statements are the backbone of any business, helping you track profits, expenses, and overall financial health. But let’s be honest: managing them manually is a headache. One mistake, and you’re stuck fixing errors instead of focusing on growth.

That’s where HashMicro’s Accounting Software changes the game. Say goodbye to long hours spent crunching numbers and hello to instant, accurate financial reports. With real-time insights, automated calculations, and smart analytics, you’ll always know where your business stands.

Why waste time on tedious accounting tasks? HashMicro simplifies reconciliations, financial reporting, and compliance so accountants can close books faster and eliminate errors. Focus on strategic financial planning while the software handles the number-crunching for you!

So, if you are interested, try the free demo now and experience the benefits yourself!

Frequently Asked Questions on Financial Statement

• What are the limitations of financial statements?

  Financial statements may not capture intangible assets like brand recognition, can vary based on different accounting methods, and often rely on estimates and judgments.

• How do International Financial Reporting Standards (IFRS) influence financial statement presentation?

  IFRS provides guidelines for financial statements, including the balance sheet, income statement, statement of changes in equity, and cash flow statement, ensuring consistency and comparability across international boundaries.

• How does the cash flow statement differ from the income statement?

  While the income statement shows revenues and expenses over a period, the cash flow statement focuses on actual cash inflows and outflows, categorizing them into operating, investing, and financing activities.

• What is the role of the statement of changes in equity?

  This statement details changes in a company’s equity during a specific period, including profits or losses, dividends paid, and any other changes affecting the equity accounts.