What financial statements are

Financial statements are the final reports a company prepares at the end of each year. They are:

• the balance sheet: what the company owns and owes on the last day of the year;
• the statement of profit and loss: its revenue, expenses and profit for the year;
• the cash flow statement: where cash came from and went;
• the notes that explain them.

What they are made of:

• Recorded facts: amounts actually recorded in the books, at historical cost (what was paid), not at today's value.
• Accounting conventions: inventory at the lower of cost or market price; fixed assets at cost less depreciation; materiality (small items like pens and stamps are simply expensed); conservatism (provide for losses, don't count gains early).
• Postulates (basic assumptions): going concern (the business will continue), money measurement (only what can be measured in money is recorded) and realisation (income is counted when it is earned).
• Personal judgements: for example, how long an asset will last, or how much to provide for doubtful debts.

That is why a balance sheet does not show what a 20-year-old building would sell for today.

Their objectives: to show the company's resources and obligations, its earning capacity, its cash flows, how well management has run it, its effects on society, and the accounting policies it used.