All of us know that financial statements are essential in telling the company’s management, investors, creditors and others about the performance and financial position of that business. As these statements play a crucial role, business owners who do not know accounting (Also see The Importance of Accounting) well often seek help from an accounting firm in Johor Bahru to ensure that the financial statements are prepared correctly. However, despite the usefulness of those financial statements in various aspects, business owners should note that they have some limitations too. In this article, we will have a look at their weaknesses in some of the aspects.
The accountants will record the business transactions based on their historical costs. Nevertheless, as time passes, the values of the company’s assets and liabilities will change. The values may also fluctuate due to market factors. The financial statements a company generates will not show these changes. Thus, the business owners (Also see How Can Accountants Help Small Business Owners?） and the stakeholders will not be able to know the exact value of the company’s assets and liabilities. Therefore, the financial statements can be misleading if the company did not carry out revaluation on those items that it has recorded based on their respective historical costs.
Also, inflation is another factor that affects the accuracy of the information contained within the financial report. In the financial statements, the values of the company’s assets and liabilities are not adjusted based on inflation. In a situation where the rate of inflation is extremely high, the values of the items that the financial reports have recorded will be lower than the actual ones. This causes the readers of those statements to be unable to obtain much information from those statements.
In the balance sheet, the readers will not be able to find the intangible assets that a company has, which include the company’s reputation, brand value and so on, that the company has earned as time passes. Even though these aspects have helped to increase the sales of the company, the company do not list them in its balance sheet. The issues on intangible assets have been a major concern among start-ups, as most of them probably have significant intellectual property. Nevertheless, as they are still new to the world of business, these intangible assets may not be able to help in attracting customers and generating sales. Thus, their sales will not be able to show the intangible assets they own, and the readers will not know about these assets too as they are not listed in the financial statements.
Apart from that, these financial statements (Also see What Investors Want To See In Your Financial Statements?) do not mention issues that are not relevant to financials. For example, one will not be able to find governance and social issues, environmental issues, as well as the steps that the company has taken to improve them in the financial report. These concerns are getting more and more crucial in this era, and the awareness of the government and business owners on these issues has raised too. However, the financial reports do not provide this information to the readers.
Another limitation of financial statements that we are going to discuss here is the risk of the occurrence of fraud. A company may use fraudulent practices due to various reasons, and doing so will cause the financial results to skew from reality. As an instance, the management may show an improved result of the company’s operations by creating fake sales or by carrying out other fraudulent practices so that they can receive a bonus from the company.
In short, financial documents are essential to the investors as these are the documents that act as a basis of their decisions. Without a doubt, they will be able to obtain a lot of information about the company by reading those statements. However, they should also consider the limitations above before making their final decision.