Critically Assess the Uses and Limitations of Financial Statements Essay

Critically assess the uses and demarcation lines of financial rehearsals The definition for a financial statement is a written idea which quantitatively describes the financial health of a company. (www. investorwords. com) It consists of a balance sheet, income statements and a cash flow statement. This essay will critically asses the uses and limitations of each of these types of financial statements for a commerce. A balance sheet shows the financial condition of a business at a specific date (Langemeier & Klinefelter 2008). It shows what is owned by the business, what is owed and the owners sh are (net worth) of the business.The balance sheet has three main uses. Firstly, it is used for reporting purposes as part of a limited companys annual accounts. These essential be shown to Companies House, HM Revenue and Customs and any shareholders unless agreed otherwise. It is in like manner used to let potential investors or lenders asses the worth of a business at any given time. This way they can judge whether they think they should be investing currency into the business according to how solvent the business is, how semiliquid its assets are, how the business is financed and how much capital is being used.Finally they can be used by the business itself to analyse how to improve its make outment. There are a few limitations of a balance sheet as some values of current assets are estimated (www. businesslink. gov. uk) therefore the balance sheet does non reflect a 100% accurate financial position of a business. Also, the fixed assets in the balance sheet have taken the depreciation of the asset into consideration and so the true value is not shown.Finally, impalpable assets such as goodwill cannot be measured and are therefore estimated figures too and may be precise inaccurate thus causing the whole balance sheet to be incorrect. Therefore a balance sheet is useful in many ship canal as long as whoever is interpreting the figures takes into consider ation that a few of the figures are not accurate. An income statement, also known as a profit and handout account, measures the profits or losses a business has made over a certain period of time (money-zine. com).If a business wishes to expand and call for a bank loan they will need to produce their profit and loss accounts for the previous three years so the bank can sop up whether they will be sufficient to repay the loan. These must be accurate records or it will be taken into account as fraud. There are many advantages of keeping accurate and up to date records. Firstly, it gives a business the information it needs to be managed and help it grow. If a business can go out where its strong or weak points are and so it can find ways to improve for example by cutting down on expenses.It also enables a business to produce their income statement quickly if required and filling in their tax return easier and quicker which in turn reduces the risk of affaire for late tax payment s. These financial statements are usually available to the public which means competitors can see how each other are doing, however very(prenominal) few people understand them when all transactions are recorded in larger companies. There are also some limitations of income statements one being that its data does not tell the user anything about what may happen in the future or factors that may affect future growth of the company.It is just now limited to accounting data. The second limitation is that not all businesses use an acceptable accounting method. An example from www. money-zine. com states that if a business decides to accelerate depreciation then they hurt short-term net income and earnings (depreciation expense is larger). If they use straight line depreciation, net income in earlier years will be high but it will be lower in the future (all things being equal). The final type of financial statement is a cash flow statement.It records the influx and outflow of cash ov er a period of time. The cash flow statement allows investors to understand how a companys operations are running, where its money is coming from, and how it is being spent. According Hertenstein Article 26 there are three main people that want to see a businesss cash flow statements. Firstly stockholders want to know if the business is generating enough cash to pay dividends. Secondly suppliers want to know if their customers will be able to pay if offered credit.Thirdly investors want to evaluate future growth potential. These types of financial accounts are cheap to maintain because you do not have to be a trained accountant to produce them as they are not a complicated as the other types of financial accounts. Though the cash flow statement is a very useful tool of financial analysis, it has its own limitations which must be kept in mind at the time of its use.The main limitation is that the cash flow statement only records cash transactions and so ignores the basic accounting c oncept of accruals and tems bought on credit and therefore are not suitable for judging the profitability of a business. Also cash flow statements are prepared using historical information which is in the past. Therefore it does not asses what may happen in the future to a businesss accounts. In conclusion, there are many uses for financial statements as they provide a solid picture of a businesss performance when compared to each other, and the users can easily spot flaws in the entitys financial position and manage these accordingly.However their limitations must be considered when analysing the data as they only supply the reader with past and present quantitative data and do not shroud any of the qualitative economic variables such as the morale of the employees or the quality of the management team. There is currently no way of measuring these intangible assets, even though a businesss human resources are some of its most valuable assets.