Financial statements communicate the financial activities and the financial position of a company for the time-frame being reported. Financial statement users compare financial statements from different companies and make decisions based on the results being reported. Users of the financial statements want to know that the financial statements are relevant and reliable.
The four primary financial statements include the balance sheet, the income statement, the statement of retained earnings and the statement of cash flows. Investors use each of these statements to evaluate company performance. Financial statement users calculate financial ratios and compare these calculations between potential investment companies.
Relevancy refers to the concept that the information being reported is meaningful. Meaningful information includes financial data that makes a difference to the user. For example, the company’s total cash balance might influence a vendor regarding the decision of selling to the company on credit; however, the vendor may not be interested in which banks hold the cash.
The purpose of making financial statements relevant is to provide financial information that the user can work with to make financial decisions. For example, a potential investor might want to consider the company’s working capital before purchasing stock in the company. Working capital uses both the current asset and the current liabilities in its calculation and tells the user how well the company is positioned to meet its current financial obligations. The financial statements present both the current assets and the current liabilities of the company.
Reliability refers to the accuracy with which the financial data is reported. The company needs to analyze each financial transaction so that the transaction is recorded accurately in the financial records. Financial statement users want to know that information reported is accurate and can be trusted.
The purpose of making financial statements reliable is to provide accurate financial information for the user to use when making financial decisions. An investor wants to know that the net income reported accurately represents the company’s activities for the period. Investors use financial statements to decide whether or not to sell their stock and the price at which they will transact. Accurate financial information assists the investor in making these decisions.