Did you ever wonder why your company has to prepare financial statements annually? This month’s blog will help explain the importance of preparing annual financial statements and highlight some generally accepted principles accountants usually observe when drafting financials.
But first, let’s start by answering this crucial question:
Why do financial statements matter?
Financial statements are crucial for all businesses, regardless of size or industry. They provide up-to-date, accurate, and detailed information about the business’s financial position. Moreover, they enable business leaders to strategise and allocate budgets.
Every organization has to report its financial activities to its external stakeholders periodically. Some of those stakeholders include investors, creditors, and SARS. One way to go about doing this is by preparing financial statements.
That said, certain principles guide the drafting process of financial statements. In South Africa, financial statements are organised within the framework of the generally accepted accounting principles (GAAP) and International Financial Reporting Standards (IFRS).
Here is how the two principles differ:
GAAP is an international convention of good accounting practices. It is a common set of generally accepted accounting principles, standards, and procedures.
If a corporation distributes its financial statements for external use, your company must adhere to GAAP. The same applies if your company trades publicly at the Johannesburg Trade Exchange.
On the other hand, International Financial Reporting Standards, commonly called IFRS, are accounting standards issued by the IFRS Foundation and the International Accounting Standards Board. IFRS specifies precisely how accountants must maintain and report their accounts.
Here are some of generally accepted principles that you should know:
- Cost principle
The cost principle refers to the notion that all values listed and reported are the costs to obtain or acquire the asset, not the fair market value.
- The information
The information on your financial statements should be clear and accurate. Any financial transaction that doesn’t concern your organization should not be recorded.
- Money measurement
Money measurement will be used as a common denominator to indicate the assets, liabilities, and owner’s equity.
This principle refers to when you choose to use the most conservative approach to determine profit.
- The accrual principle
This principle states that when we calculate profit for a specific period, we will consider only income earned during that period. Moreover, only the value consumed during that period should be regarded as an expense to determine profit.
To achieve this, an accountant must have an up-to-date financial record of all your financial activities. Furthermore, an accountant will classify, record, and summarise all your financial transactions.
- The realisation principle
With this principle, your company must meet two critical conditions: First, your organisation must earn its income. Secondly, it must realise that income.
Here are some of the external stakeholders that use financial statements.
- Money lenders
There are times when your company will need to borrow funds to keep the business afloat. Lenders will use your financial statements to assess the financial health of your business venture. Additionally, the credit bureaux may need financial statements to issue credit ratings.
According to GAAP, every publicly traded company must release its financial statements yearly. Investors use these statements to determine the financial health of the company and its suitability for investment or extension of credit. The financial statement must be accurate to allow investors to assess your company.
3. Executive management
Your executive management cannot strategise and control the activities of an organisation without using accurate financial statements.
Employees may use financial statements to acquaint themselves with the business’s financial position.
Your shareholders will need financial statements to assess the worth of your business. Shareholders will use financial reports to evaluate your company’s revenue, expenses, profitability, liability, and the ability to meet its short-term and long-term financial obligations.
SARS requires financial statements to check whether the amount of taxes paid is accurate. Besides, it is a further legal requirement that businesses keep their annual financial statements (AFS) safely and make them available upon request.
As an operating company, your AFS must contain the following:
- Income Statement;
- Balance Sheet;
- Tax Computation; and
- Notes to the AFS.
For all other Company classifications (Dormant, Body Corporate, Share Block, and Microbusiness), the submission of the AFS are optional.
Private or personal liability companies that are required to be audited by the Companies Act, 2008 or regulation 28, must file a copy of the latest approved Audited Financial Statements on the date that they file their annual return with the CIPC.
Lastly, the accounting for an organization should be kept separate from its owner’s personal affairs or any other business or organization.
Put differently; you should not place personal assets on the business balance sheet as a business owner. Your company’s balance sheet should reflect only the financial position of your business venture alone.
Do you need help with the preparation of your financial statements? Reach out to us today!