Question

Explain the statement of financial position and its uses and limitations

Answer 1

Statement of financial position is often called the Balance sheet. This statement shows the financial position of the organisation on a particular date. It reflects the position of assets, liabilities and equity of the company as on the reporting or particular date.

It is the most important books of accounts out the three, the other two being Income Statement and Cash Flow Statement. An up-to-date balance sheet is very much needed for any business stakeholder for there decision making. It shows the net worth of the business organisations. It is built upon the concept of Accounting theory, the equation being

Assets = Equity + Liabilities.

Uses of It being:

• Used for Comparison- period to period figures or industry to industry can be compared for business decisions on the financial health
• Meeting Financial Obligation- by looking at the positions of funds and assets, planing can be done to meet with obligations.
• Measure of Success: the position of the organisation reflecting through balance sheets helps in calculating various business performance ratio, which helps the analyst to measure the success of the organisation.
• Calculate Tax- government or the company itself uses these figures to calculate the taxes to paid to the government accurately.
• Credit Worthiness: the lenders to the organisation will ascertain the credit worthiness by the use of balance sheet figures

Its Limitation being:

• Not flexible: It cannot use market values, it depends on mainly on historical cost. So, actual market value may be different form what it is shown.
• Different accounting methods: comparison may be difficult when different methods used by different organisation or between the periods.
• Assumptions: few human assumptions are made like provision for bad debts, depreciation or other provision which may be not correct actually.