A business’s financial statements are one of the primary sources of information for a potential investor. They can help you answer questions such as what is company’s net worth and how much cash you have. Although they are tremendously helpful to a business, there are nonetheless many limitations of the financial statements. Every stakeholder should be aware of the limitations so as to decide the limit of reliance on the financial statements.
The financial statements are useful in analyzing the business and its performance. But, there are a few limitations of financial statements. Some of these are as follow;
A company’s intangible assets are not reported on its financial statements. Intangible assets, such as brand value and reputation earned over a several years of its operation, which help a company generate more sales, are not included in the balance sheet. A business’s value can be drastically underestimated by this policy.
Every company uses different accounting practices to prepare financial statements. Different accounting practices make it difficult to compare a company’s financial statements with those of other companies.
Financial statements are publicly available, so a company or business organization cannot disclose all the information as the competitor may steal it and use it for its own purposes. Therefore, the organization must limit itself while publishing public information and adhere to the law’s protocols. Another reason for the limitations on financial statements is that anyone can manipulate the information.
The assets purchased by the company and its liabilities change with time and are influenced by market forces. However, the transactions on the financial statements are recorded at historical cost. Hence, they do not provide the current value of an asset. The financial statements can be misleading if any items are based on historical costs and the company has not revalued them.
There is no inflation adjustment for the company’s assets and liabilities. As a result, if inflation is high, the items in the reports will be recorded at lower costs, resulting in less information for the reader. The majority of long-term assets fall into this category.
The financial position and operating results of a business are affected by certain factors, but they are not included in these statements since they cannot be quantified. Management reputation, creditworthiness, environmental attentiveness, employee cooperation, and so on are some of these factors. Accounting statements only show the financial position of the business, not its non-financial position.
Financial statements cannot be precise because they deal with matters that can’t be accurately stated. Over the years, conventional procedures have been followed to record the data. A variety of conventions, postulates, personal judgments, etc., are used to develop the data that can be not precise.
Financial statements often contain forward-looking statements, but they cannot be used to make predictions about the business. Analysts use financial statements to predict the company’s sales and profits in future quarters based on the company’s historical performance. As a result, financial statements alone cannot predict a company’s performance in the future.
Financial statements cover a specific period; seasonality and sudden spikes/dullness in sales can be affected by them. As many parameters affect a company’s performance, and that is reported in the financial reports, one period cannot easily be compared to another. As a result, readers can make mistakes when analyzing reports based solely on one reporting period. It is possible to gain a better understanding of how the company is performing by reviewing reports from various periods and analyzing them prudently.
Assets in the statements are valued according to the standards of the person who handles them. Accounting methods, such as depreciation and amortization, depend on the accountant’s judgment.
In conclusion, financial statements are a valuable tool. They can provide insight into the past and predict future success. However, it is important to realize any shortcomings in these statements to get a clearer picture of the company.