Question

The statement of financial position shows how much a business is worth.’ Do you agree with this statement? Discuss.

Answer 1

Answer :

The statement of financial position shows how much a business is worth.’ Do you agree with this statement? Discuss.

None of the financial statements will report the value of a business. The main financial statements (balance sheet, income statement, statement of cash flows, statement of stockholders' equity) may provide some helpful partial information, but they will not report the value of the business.

Two reasons why the value of a business is not included in the financial statements are:

• The financial statements are generally based on the company's past recorded transactions. The value of the business will more likely be based on the perceived future transactions.
• The accountants' cost principle prohibits a business from reporting some highly-valued assets such as trademarks, brand names, and an effective management team (assuming these were developed internally).

A contemporary example which demonstrates that the financial statements do not reflect the value of a business is a startup company with a promising future. We may have read that a venture capitalist (VC) invested $10 million in a startup. Based on that investment the startup is assumed to have a total value of $100 million. Well the startup's financial statements will not report amounts anywhere near $100 million. Realistically the financial statements will be reporting negative earnings, few assets and little stockholders' equity. The company's value came from the VC's perception of the company's new breakthrough system that is projected to generate amazing future revenues with a limited amount of expenses.

In short, the financial statements provide only some of the information needed when attempting to determine the value of a business.

However, A statement of financial position shows the value of a business on a particular date in book value terms.

A net worth is termed as the book value or its owner’s capital. Net worth of the company is the balance of all assets value subtracting the amount of liabilities. Financial statements are prepared to inform the company’s stakeholders about the performance and worth of the business. The International Accounting Bodies made rules and regulations to keep record of every financial transaction. And proposed 4 types of reports which are mandatory for every company to prepared and published.

These reports are prepared at the end of every financial year. They include

• Balance sheet
• Income statement
• Cash flow statement
• Changes in Owners’ Equity

Another compulsory part of financial statement is termed as notes to the accounts. The company accounting policy and calculations are provided in the notes so the reader will have a good idea about the basis of calculation.

Purpose of Financial Statement:

The purpose of financial statements is to provide information to the company stake holders. So that they can make their strategies for the future. Every financial report has a specific purpose. Like income statements show the company net income for the period. In other words it sums up the total revenue and total expenses of the business. The cash flow is prepared to show the sum of total cash transactions and availability of cash for the business. The changes in owner’s equity is for the shareholders which gives information about the total net investment of the shareholders. New investors can use this information to determine the dividend and other policies for the shareholders.

Net Worth of the Company:

And if you want to calculate the net worth of the company, then you have to look for the balance sheet. You can easily estimate the net worth by the following formula:

Net Worth = Total Assets – Total Liabilities

But if you calculate negative net worth for a company which is stable from a long time, then there is some danger and management have to look for some solution. The information about the net worth of a company is important for every owner of the business. So that he will have an idea of what he has. And he can compare these calculations from time to time to identify whether the changes the positive of negative.The net worth calculation is important for all types of business. It does not necessary if your organization is big or small, this statement is useful for all the companies.