Financial statements

A financial statement is a report that shows the financial information of a business, whether that is a listed company, unlisted or not-for-profit enterprise.

What are the four basic financial statements?

1. Balance sheet: A snapshot of a firm’s financial situation at a single point in time. Shows your business assets, liabilities and owner's’ equity.
   
2. Profit and loss statement:  Shows revenues, costs and expenses over a specific period of time. (Also called an income statement.)
   
3. Cash flow statement:  Shows changes to cash coming into and going out of a business over a period of time. Only records cash (not all income). Shows whether you can cover short term expenses like bills and payroll.
   
4. Statement of movement in equity: also called a statement of retained earnings. Shows changes in the equity of your business for a set time period. In other words, changes in how much money your business keeps (rather than pays out to shareholders).
   

Combined, these statements provide a good view of the financial health of an operation. Essentially, financial statements are written records that convey the business activities and the financial performance of a company. Financial statements are often audited by government agencies, accountants, firms, to ensure accuracy and for tax, financing, or investing purposes.

Objectives of financial statements

Financial statements of companies are used by investors, market analysts and creditors to evaluate a company's financial health and earnings potential. Financial reporting and statements are not the only source of information for investors, but they are the primary source of information for investor decision making. Accordingly, annual financial reports are an important communication tool for companies, not just an exercise in compliance.

Investors and financial analysts rely on financial data to analyse and interpret the performance of a company and make predictions about the future direction of the company's stock price. One of the most important resources for reliable and audited financial data is the annual report, which contains the firm's financial statements.

Financial statements, which must meet financial reporting standards, play an important role in investor decision making and primarily confirm current performance. They are seen as a reliable starting point for prediction of future performance. Accordingly, directors should be mindful of the key role of financial reporting in communicating performance to investors.

Finance governance

Most organisations in Australia prepare an end of financial year statement (June 30) and directors are asked to sign off this statement. Half-yearly, quarterly and other financial statements are also prepared.

As EOFY approaches, directors should be able to understand if the results they are presented with show a true and fair view of operations as well as how the business is performing against its competitors. The Federal Court in the Centro case (ASIC v Healey 2011) made it very clear that in approving financial statements, directors must bring their own knowledge of the company’s situation to bear and cannot simply rely on auditors or management. If in doubt about anything in the financial statements, directors must ask questions.

To be on top of this task, Lisa Cook, founder and managing director of Get on Board Australia and a non-executive director of several boards, says directors should:

• Avoid surprises If the organisation is not meeting targets, this should already be known and remediation plans put in place.

• Not assume (and spend) surpluses until they are actually recognised. EOFY adjustments may change your projections.

• Make sure there is timely preparation and audit of accounts and consider what effect any new accounting standards or regulations may have on results.

• Ensure there is rigorous and timely budget preparation for the year ahead if not already using rolling forecasts.

• Check processes are in place to manage business risks. Risk matrices should be updated and any gaps addressed.

• Ensure insurances have been reviewed and appropriate cover is in place for key risks.

Key Points

• The balance sheet provides an overview of a company's assets, liabilities, and stockholders' equity as a snapshot in time. The date at the top of the balance sheet tells you when the snapshot was taken, which is generally the end of the fiscal year.

• The income statement primarily focuses on a company’s revenues and expenses during a particular period. Once expenses are subtracted from revenues, the statement produces a company's profit figure called net income.

• The cash flow statement (CFS) measures how well a company generates cash to pay its debt obligations, fund its operating expenses, and fund investments.

Not-for-profit financial statements

Charities must report each reporting period to the Australian Charities and Not-for-profit Commission. They need to submit an Annual Information Statement (AIS) and an annual financial report (if medium or large in size). This must include charity fundraising.

• Small charities have annual revenue under $250,000

• Medium charities have annual revenue over $250,000 but under $1 million

• Large charities have annual revenue of $1 million or more.

What financial information must a charity provide to ACNC?

All registered charities - except those registered with Office of the Registrar of Indigenous Corporations (ORIC) and members of an ACNC approved reporting group - must submit an Annual Information Statement. The Annual Information Statement contains a section on charity finances.

Medium and large charities - those with total annual revenue of $250,000 or more - must submit an Annual Financial Report along with their Annual Information Statement. Small charities are encouraged to submit an Annual Financial Report, but it is optional.

Note that charities that are a member of an approved reporting group are not required to submit individual Annual Information Statements, and instead should submit a single AIS via group reporting.

Charities which need a financial statement template should visit the Australian Charities and Not-for-profit Commission website.

COVID-19 financial statement disclosure

In the current COVID-19 environment, with circumstances changing daily and governments making previously unheard-of policy interventions, it will be very difficult for many entities to project out over 12 months with any degree of certainty. For many reporting entities, any projection will have to be so heavily qualified that users of financial statements will be able to gleam very little information as to the true prospects of the company. The disclosures also raises the potential for conflict with auditors because of the difficulty of making judgments over these issues and changing circumstances between director declarations and auditor’s assessment.

The Australian Securities and Investments Commission (ASIC) has announced that it
will extend the deadline to lodge financial reports by one month for both
listed and unlisted entities with balance dates from 31 December 2019 to 7 July
2020. The 7 July 2020 date accommodates entities that use a provision in the
Corporations act enabling their financial year to be changed plus or minus 7
days each year.

ASIC has advised that, where possible, entities should continue to lodge within the
statutory deadlines having regard to the information needs of shareholders,
creditors and other users of their financial reports, or to meet borrowing
covenants or other obligations.

Importantly, listed entities will be required to inform the market when they rely on the
extended period for lodgement. ASIC also indicates there will be an expectation
for those entities to explain the reasons for relying on the extension period.

ASX-listed entities required to lodge their Appendix 4E under ASX Listing Rules
4.3A and 4.3B by 31 August 2020 (for 30 June 2020 year ends) that do not have
audited accounts by that date, will need to lodge unaudited accounts with its
Appendix 4E.

The Australian Charities and Not-for-profits Commission has provided blanket extensions to charities whose 2019 Annual Information Statement is due between 12 March and 30 August 2020 to 31 August 2020.

Assessment of going concern

Directors are required to assess going concern; that is whether the company can continue in operation for the next 12 months without any intention or necessity to liquidate or otherwise wind up its operations. Directors are required to publish this view in their financial statements and the auditor is required to form an independent view on its reasonableness. Assuming the entity is a going concern the accounts will then be prepared on a going concern basis.

To project out over 12 months directors, will need to form judgments on matters such as:

• liquidity risk;

• impairments of tangible and intangible assets including goodwill;

• the extent of potential operational disruption;

• potential diminished demand for products or services;

• access to capital;

• recovery of receivables and bad debt.

Directors may be able to deal with the going concern assessment by making a going concern statement with a material uncertainty around COVID-19 related issues. This will require disclosure by directors of some details of how COVID-19 has created a material uncertainty. For further guidance see this publication from the Auditing and Assurance Standards Board (AUASB). Auditors might react by issuing an unqualified opinion with an emphasis of matter paragraph detailing the COVID-19 material uncertainties set out by directors. 

Declaration of solvency

At least annually, and half yearly in the case of listed companies, boards are required to pass a solvency declaration declaring that they have reasonable grounds to believe the company is solvent; that is whether they have reasonable grounds to believe the company can pay its debts as and when they become due and payable. A published directors’ report must refer to that resolution. In audited financial statements, the auditor is required to publish their opinion on the board’s declaration. A board that makes a negative statement of solvency would need to consider immediately moving to a voluntary administration or winding up.

Many boards may, for the first time, be considering issuing qualified statement to solvency. ASIC has said previously that such qualified statements are permissible, and their Regulatory Guide 22 - Directors’ statement as to Solvency, explicitly deals with the issue. Notably that ASIC guidance, issued in June 1992, may need to be re-visited if the economic shock of COVID-19 is as large, and long-lasting, as some experts fear.

Given the Government has legislated a temporary safe harbour for directors from insolvent trading (see here), the AICD believes that broader policy settings, including with respect to solvency declarations, need to align with the Commonwealth’s objective of encouraging organisations to trade through the current crisis. Specifically, the desired impact from turning off insolvent trading liability could be undermined if directors rush towards voluntary administration given fears regarding solvency declarations. Importantly, it remains an offence for a director to provide a declaration of solvency without having reasonable grounds for his or her opinion.

Impacts of COVID-19 on annual report disclosures

We have joined with Chartered
Accountants Australia and New Zealand (CA ANZ) and CPA Australia to publish guidance on the disclosure and reporting of COVID-19 impacts on entities.

The Impacts of COVID-19 on annual report disclosures: a guide for directors, managers and auditors, was prepared recognising the nature of the challenges posed when disclosing the impact of COVID-19 in annual reports for the 30 June 2020 reporting
season.

It aims to be a useful guide for listed and unlisted-listed entities, including not-for-profits, charities and small to medium entities. See the guide here.