KAMPALA INTERNATIONAL UNIVERSITY

COLLEGE OF ECONOMICS AND MANAGEMENT

COURSE : MBA- FINANCE AND ACCOUNTING

NAME : TURYABANZA EDISON

REG NUMBER :2025-01- 35095

YEAR :TWO

SEMESTER :ONE

COURSE UNIT :FINANCIAL STATEMENT ANALYSIS

LECTURE : DR. RUTARO ABAS

QUESTION
Who are the users of Financial Statements and how important are they to the
Users?
Financial Statements

A financial statement is an official document that records the financial activities and status of a business,
giving a complete description of the company’s financial activity during a predefined period. The three
components that help establish the financial conditions of a business these are the income statement,
balance sheet and cash flow statement. These statements are crucial for companies, investors, creditors
and regulatory bodies, as it gives them a detailed insight of a company’s financial status. Financial
statements capture revenue, expenses, capital, and how they are used to deliver results.

The income statement analyzes the profitability of a company over a particular period of time, the
various assets, liabilities and equity of the company are mentioned in the balance sheet and the cash flow
describes the cash going in and out of the company. Helping stakeholders make informed decisions,
determining the financial health of the company and assisting in financial reporting. There are some of
the benefits of financial statements.

With financial statements businesses can monitor their performance, develop strategies for the future,
and comply with regulatory requirements. These statements also help cement trust and confidence
between the business and other involved parties.

Financial statements are necessary for businesses to track their finances, analyze performance, and
adhere to regulations. These documents – The statement of the statement of comprehensive income,
statement financial position, , and cash flow statement – provide a company with a holistic financial
overview. They are primarily designed to inform stakeholders, such as shareholders, managers, and
regulators, on profitability, liquidity, and solvency.

Financial reports also play an important role in decision-making, forecasting and financial management,
which makes them critical for small and large businesses.

Financial Statements Components and Purpose

A financial statement is an organized, formal report of a company’s finances during a particular period.
They offer a detailed look at the financial transactions, performance, and status of a business that will
 help stakeholders see how well the company is doing. Financial reports are generally prepared quarterly
or annually and serve both internal management and external parties like investors and regulators.

The three primary financial statements that provide insights into a company’s operations are as follows.

Statement of comprehensive income

The statement of comprehensive income, also known as the profit and loss (P&L) statement, is a
fundamental financial statement providing an in-depth, period-to-period account of a company’s
financial performance. The P&L statement records all of a company’s revenues generated from primary
operations, for example, sales of products or services and distinguishes them from non-operating
revenues, such as interests or rents. The statement also lists operating expenses like the cost of goods
sold (COGS), salaries, rental payment utilities, and repairs, and non-operating expenses such as interest
payments.

Furthermore, the statement of comprehensive income mentions the gains and losses from non-recurring
events, such as the sale of an asset or lawsuit settlement. It subtracts total expenses and losses from total
revenues and gains to derive the net income, which indicates the company’s profit for that period. The
net income also provides insights into the operational effectiveness of the company.

Components of the statement of comprehensive income

1. Revenue (Sales):
 Operating Revenue: Income generated from the company’s principal activities, such as the
sale of goods or services.
 Non-Operating Revenue: Income from non-core activities, such as interest income, rental
income, or royalties.
2. Cost of Goods Sold (COGS):
 The cost of materials and direct labor incurred in the production of the goods or services sold.
3. Gross Profit:
 This is Revenue – COGS, showing the profit that is generated by the core business operations
before operating expenses are factored in.
4. Operating Expenses:
  Selling, General, and Administrative Expenses (SG&A): Costs related to selling
products/services or managing the business, such as wages, rent and utilities.
 Research and Development (R&D) Expenses: Expenditures on developing new products or
services.
 Depreciation and Amortization: The systematic allocation of the cost of tangible and
intangible assets over the period they are used.
5. Operating Income (Operating Profit):
 It is calculated as Gross Profit – Operating Expenses. It reflects the earnings from routine
business operations.
6. Non-Operating Income and Expenses:
 Gains: Profits from non-core operations, like selling an asset for more than its book value.
 Losses: Costs or losses of value to non-core activities, for example, payouts in a lawsuit or a
write-down on an asset.
 Interest Expense: Costs incurred from borrowing funds.
 Interest Income: Earnings from invested funds.
7. Net Income:
 After all revenues, gains, expenses and losses have been taken into consideration, reports the
final profit or loss.

The income statement could be presented in either a single-step or multi-step format, depending on
regulatory requirements or stakeholder preference. The financial report can be used by investors,
creditors and management, as it provides an analysis of the company’s financial status and operational
efficiency. It also points out the underperforming areas of the company and helps management make
strategic decisions in order to ensure future profitability.

Statement of financial position

The statement of financial position is a key financial statement that summarizes the financial position of
a company at a given point in time by reporting the assets, liabilities and shareholders’ equity of a
company. The balance sheet is one of the major financial statements – in addition to the income
statement and statement of cash flows – used to evaluate the liquidity and profitability of a business.

The financial position is organized with the below accounting equation:

 Assets = Liabilities Shareholders’ Equity

The balance is preserved by this equation, which reflects the principle that all assets are financed
through either debt (liabilities) or investment from owners (equity).

Also Read: Balance Sheet Formats

Components of the Balance Sheet

 Assets: These are economic resources controlled by the company. They are typically categorized into:
o Current Assets: Items expected to be converted into cash or used up in the coming year,
including cash, accounts receivable, and inventory.
o Fixed Assets: Assets that are long-term resources used in operations, such as land, buildings,
machinery and equipment.
 Liabilities: These are the payments a company owes its creditors. They are divided into:
o Current Liabilities: Debts owed within the next 12 months, including accounts payable and
short-term loans.
o Long-Term Liabilities: Obligations due after one year, such as mortgages and long-term loans.
 Shareholders’ Equity: This section encompasses the interest of owners after liabilities are subtracted
from assets; it includes common stock, preferred stock, paid-in capital and retained earnings
(accumulated revenues not distributed as dividends).

The balance sheet is essential to the interests of the company’s investors creditors, and management.
They use it to understand a company’s liquidity, financial flexibility and capital structure, and to help
them decide whether or not to invest, loan funds, or make other strategic decisions for business
operations.

Cash Flow Statement

A cash flow statement (CFS) describes a company’s cash movements – where the company derives its
cash and how it spends it. The CFS supplements the balance sheet and the income statement and helps
the investors assess the overall financial health of the company.

The CFS is divided into three sections:

1. Operating Activities: This section describes cash flow from core business operations – sales, wages,
taxes, accounts receivable, depreciation and amortization, inventory and accounts payable are all
included here.
2. Investing Activities: It reflects cash used for loans, mergers and acquisitions, acquiring more property,
plant and equipment.
3. Financing Activities: It includes cash flows related to borrowing or equity, for example, debt or equity
issuance, stock repurchases dividends, debt repayments and loans.

Collectively, these sections reconcile the income statement and the balance sheet, showing the overall
cash position of the company.

USERS OF FINANCIAL STATEMENTS

1. Owners and investors

Stockholders of corporations need financial information to help them make decisions on what to do
with their investments (shares of stock), hold, sell, or buy more.
Prospective investors need information to assess the company's potential for success and
profitability. In the same way, small business owners need financial information to determine if the
business is profitable and whether to continue, improve or drop it.
2. Management

In small businesses, Management may include the owners. In huge organizations, however,
management is usually made up of hired professionals who are entrusted with the responsibility of
operating the business or a part of the business. They act as agents of the owners.
The managers, whether owners or hired, regularly face economic decisions – How much supplies
will we purchase? Do we have enough cash? How much did we make last year? Did we meet our
targets? All those, and many other questions and business decisions, require analysis of accounting
information.
3. Lenders
Lenders of funds such as banks, financial institutions, and bondholders, are interested in the
company’s ability to pay liabilities upon maturity (solvency).
4. Trade creditors or suppliers
Like lenders, trade creditors or suppliers are interested in the company’s ability to pay obligations
when they become due. They are nonetheless especially interested in the company's liquidity – its
ability to pay short-term obligations.
5. Government
Governing bodies of the state, especially the tax authorities, are interested in an entity's financial
information for taxation and regulatory purposes. Taxes are computed based on the results of
operations and other tax bases. In general, the state would like to know how much the taxpayer
makes to determine the tax due thereon.
6. Employees
Employees are interested in the company’s profitability and stability. They are after the ability of
the company to pay salaries and provide employee benefits. They may also be interested in its
financial position and performance to assess possibilities of company expansion, and with it, career
development opportunities.
7. Customers
When there is a long-term involvement or contract between the company and its customers, the
customers become interested in the company’s ability to continue its existence and maintain
stability of operations. This need is also heightened in cases where the customers depend upon the
entity.
For example, a distributor (reseller), the customer in this case, is dependent upon the manufacturing
company from which it purchases the items it resells.
8. General Public
Anyone outside the company such as researchers, students, analysts and others could be interested
in the financial statements of a company for some valid reason – be it for personal research,
industry and sector analyses, school report, or simply to satisfy one's curiosity.
Internal and External Users
The users may be classified into internal and external users.
Internal users refer to managers who use accounting information in making decisions related to the
company's operations.
External users, on the other hand, are not involved in the operations of the company but hold some
financial interest. The external users may be classified further into users with direct financial
interest – owners, investors, creditors; and users with indirect financial interest – government,
employees, customers and the others.

Importance of Financial Statements

Financial statements provide a transparent and accurate view of a company’s financial position.
Company stakeholders, such as management, investors, lenders, and regulatory authorities, use these
documents, which are prepared periodically, to assess their financial performance and take the required
action.

Below are reasons that describe the importance of financial statements.

Decision-Making for Management

Financial statements can offer details on how the company is performing. The income statement and
cash flow statement present the profitability of the company, whereas the balance sheet shows the
liquidity and solvency details. Using these statements, management can decide on future investments,
cost-cutting and operational enhancements as they will have an idea about the present state of the
business.

Investor Confidence

Financial statements help investors assess the soundness of a company. They can answer questions such
as – how prudently the company is being run, how strongly it is positioned to survive and if it is capable
of growth. It can help investors decide whether to buy, hold, or sell, and if so, how much. A company
with good, clean financials inspires greater confidence and trust, making it easier to raise money from
investors, banks and private equity.

Regulatory Compliance

Companies in almost every country are compelled by law to prepare and file periodic financial
statements, which must conform with accounting standards prescribed by the financial authorities. This
leads to the creation of financial statements that are intended to provide a true and fair view of a
company’s financial position. It further helps maintain integrity in the financial markets and legally
protect stakeholders.

Creditworthiness for Lenders

When a company applies for a loan or other credit facilities from banks or financial institutions, they
examine the financial statements of that company before approving or rejecting the request. Well-
prepared financial statements help lenders to gauge a company’s ability to repay its loans, efficiently and
effectively manage its assets, and maintain sufficient cash to stay in business. Based on this data, they
will determine the level of risk involved and lending terms.

Benchmarking and Performance Evaluation

Financial statements allow businesses to measure their results against industry benchmarks, peers and
competitors. By focusing on financial ratios and comparing them with other companies in the same
industry, can help businesses find their strengths and weaknesses, and look for possibilities to develop
themselves. Periodically reviewing performance allows businesses to be more deliberate and strategic in
their decision-making.

Tax Planning and Compliance

Financial statements are helpful for tax planning – that is, they help a business to understand what its tax
liability will be and how to minimize its tax bill. When presented with an accurate picture of revenue
and expense levels, the Financial statements assist a business in preparing for tax filing, as well as
ensuring it meets the jurisdiction’s tax framework.

Benefits, Scope and Objectives of Financial Statements

Financial statements provide a simple, structured and consolidated view of a company’s financial
position. Their applications are not only limited to the internal decision-making of a business but also
extend to other stakeholders, customers and external parties such as investors, lenders and regulators.

Scope of Financial Statements

The scope of financial statements extends to internal teams and external parties such as investors. Let’s
look at some areas where financial statements play a vital role.

Internal Business Management

Internal teams can use income and cash flow statements to understand if the current operations are
effective or if they need to be improved. Financial statements can also aid in budgeting, forecasting and
defining objectives that align with the company’s vision.

Analysis by External Parties

To investors, the scope of financial statements includes judging a company’s growth prospects,
profitability and financial strength. These reports help them determine whether to purchase, retain or sell
shares of the company in question.

Evaluation by Lenders

Banks and financial institutions rely on financial statements to assess a company’s creditworthiness
before extending loans or credit facilities. A strong balance sheet and consistent cash flow indicate a
company is financially stable and can manage its debt obligations.

Regulatory and Tax Compliance

Financial statements serve as a control mechanism, to ensure companies comply with legal obligations.
In most jurisdictions, financial reports must follow accounting standards like I AS. Adherence to these
regulations can help avoid expensive legal penalties.

Strategic Planning and Forecasting

By studying past financial data, businesses can predict future trends, anticipate expenses and to find out
ways to overcome potential threats. The proactive approach can safeguard the business in the face of
changing market conditions.
The scope of financial statements serves a wide array of needs – from internal management operations to
financial assessments for investors and creditors. They are essential to business planning, regulatory
compliance and sound financial health.

Nature of Financial Statements

The nature of financial statements highlights the features and limitations that describe its role in
financial reporting. They present a standardized perspective of a business’s financial performance and
position.

Here are some of the key aspects of their nature.

Historical Nature

Typically, financial statements are prepared using historical data. They present how the company’s
business has been conducted in the past rather than at present. The information they contain does not
necessarily predict future outcomes. While users can benefit from information about past performance,
they should consider this limitation when making decisions for the future.

Based on Accounting Principles

Rules governing the nature of financial statements are set in accounting standards such as INDAS. These
ensure that information reported in financial accounts is consistently recorded and reported from one
company to the next, which aids independent comparison. However, accounting standards have their
own rules, which may not record all aspects of a company’s activities in a way that matches the realities
of its operations with non-financial elements, such as employee spirit or brand strength.

Reliance on Estimates

Several numbers in financial statements are estimates and judgements. For instance, depreciation,
amortization, and provisions for doubtful debts necessitate management to make guesses. Although such
estimations are based on good reason and are in accordance with accounting regulations, they involve
some degree of subjectivity, which can affect the final reported figure. This subjective quality forces
users to scrutinize the accuracy of the data.
Limited Scope of Intangible Assets

One of the shortcomings of financial statements is that they are not always able to adequately describe
the value created by intangible assets. These intangible assets are not always easy to quantify and put on
balance sheets but can account for a large percentage of a company’s success, for example, brand
reputation, intellectual property and employee know-how. This means that financial statements are
sometimes unable to completely capture a company’s true value.

Static Nature

Financial statements are snapshots of a company’s financial position at a specific date in time, or over a
period such as a year. Subsequent changes in the market environment, technological innovations,
regulatory changes, are not reflected in the numbers in the financial statements. Users need to
supplement the financial statements with real-time data to get an updated financial view of the business.

Legal and Regulatory Framework

A region’s legal and regulatory environment affects the way a company prepares its financial
statements. The report structures must adhere to the rules set by the government and regulatory
authorities. This ensures that financial reporting is transparent and fair. Ultimately, it protects investors
and ensures that financial statements are prepared according to generally accepted and applicable
standards.

The nature of financial statements emphasizes their characteristics and uniform approach to financial
reporting. It also highlights limitations such as historical data, use of estimates and the effect of
intangible assets.

Financial statements help in detecting financial fraud

Inconsistencies or strange patterns in financial statements could suggest accounting fraud. For instance,
large discrepancies in reported cash flow, a boost in revenue that doesn’t match actual operations, or
unexplained and large expenditures might point to fraud. Auditors and forensic accountants make use of
these types of documents to identify fraud.
While financial statements are prepared based on historical data, these statements help predict future
performance. By observing trends in revenues, expenses and profits, companies can forecast potential
future results and accordingly plan their operations.

Financial Statements support tax planning

Financial statements provide a fair and transparent view of a company’s revenue and costs, which is
crucial for calculating tax liabilities. These statements can help reduce expenses, and identify tax-saving
opportunities while staying compliant.
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