Financial Position
Financial position is a company’s ability to accomplish its short-term and long-term goals consistent with its strategy. When people ask, “How are we doing financially?” the answer should reflect that organization’s financial position.
An organization’s financial position has four main components:
- Liquidity. Does the organization have liquid resources to cover its near-term liabilities?
- Profitability. Do the organization’s revenues cover its operating expenses?
- Solvency. Can the organization generate enough resources to cover its near-term and long-term liabilities?
- Efficiency. Is the organization using and managing its assets well?
Informed Business Decisions Competencies
- Align HR decisions with organizational strategy.
- Assess the organization’s financial and operating information for impact on HR strategy.
Source: HRPA Professional Competency Framework (2014), pg. 20. © HRPA, all rights reserved.
To understand a business, a standard recommendation is to read that business’s financial statements. Financial statements are reports that communicate an organization’s financial performance and financial position.
The two primary objectives of every business are profitability and solvency. Profitability is the ability to generate income. Solvency is the ability to pay debts as they become due. Unless a business can generate satisfactory income to pay its debts, the business cannot survive.
There are four basic financial statements: the Income Statement, the Statement of Owners’ Equity, the Balance Sheet, and the Statement of Cash Flows. Together they present the profitability and strength of a company:
- An income Statement (also referred to as a statement of profit and loss) is a summary of the revenues and expenses of a business over the financial period (usually a year). This statement reflects a company’s profitability.
- The Statement of Owner’s Equity is a summary of the change in the value of equity in the business. Equity is essentially the value of the business after debts are paid.
- The Balance Sheet (also referred to as a statement of financial position)is a snapshot of the assets, liabilities, and equities of the business at a specific date in time. This statement reflects a company’s solvency.
- The Statement of Cash Flows is a summary of the cash coming into and going out of the business over the financial period (usually a year).
- This statement reflects a company’s liquidity.
In essence, the overall purpose of financial statements is to evaluate the performance of a company, governmental entity, or not-for-profit entity. Each financial statement listed has a unique function, and together they provide information to determine whether a company generated a profit or loss for a given period; the assets, which are resources of the company, and accompanying liabilities, which are obligations of the company, that are used to generate the profit or loss; owner interest in profits or losses; and the cash position of the company at the end of the period.
Although the specific headings and elements included in each statement depend on the company’s type of business, they are often very similar and follow accounting standards. Standardized formats were established to ensure the company reported accurately honestly and transparently. This also enables comparison of the financials between companies.
For example, without standardized formats, it could be difficult to compare the financial data of a company in the service industry to the one in manufacturing. The structures of the companies, as well as how they generate income are very different. The standardized nature of financial statements, however, allows anyone to see the key information about the companies’ performance in a similar way, despite the differences. This allows the management team and potential investors to navigate the statements and obtain relevant financial information about the company without having to delve into the intricacies of a company’s business.
Purpose of Financial Statements
To understand the purpose of financial statements, it is important first to consider the users of financial statements, often referred to as stakeholders. A stakeholder is someone affected by decisions made by a company; this can include groups or individuals affected by the actions or policies of a business or organization, including investors, creditors, employees, managers, regulators, customers, and suppliers. The stakeholders’ interest is sometimes unrelated to the entity’s financial performance. Stakeholders include lenders, investors/owners, vendors, employees and management, governmental agencies, and the communities in which the businesses operate. Stakeholders are interested in the performance of an organization for various reasons, but the common goal of using financial statements is to understand the information each contains that is useful for making financial decisions. For example, a banker may be interested in the financial statements to decide whether or not to lend a business money.
Likewise, small business owners may make decisions based on their familiarity with the business – they know if the business is doing well or not based on their “gut feeling.” By preparing the financial statements, accountants can help owners by clarifying the business’s financial performance. Nowadays, businesses record most of their transactions in real-time and can access accounting information without their accountant with clever accounting systems that integrate seamlessly into their everyday business processes.
It is important to understand that, in the long term, every business activity has a financial impact, and financial statements are a way that accountants report the activities of the business. Stakeholders must make many decisions, and the financial statements provide information that is helpful in the decision-making process.
Financial Position is adapted from “Chapter 3: Financial Statement Analysis” from Financial Strategy for Public Managers Copyright © 2023 by Sharon Kioko and Justin Marlowe is licensed under a Creative Commons Attribution 4.0 International License, except where otherwise noted.
Financial Statements is adapted from “2.1 Financial Statements” from Engineering Economics Copyright © by Schmid, B., Vanderby, S. is licensed under a Creative Commons Attribution 4.0 International License, except where otherwise noted.
The section “Purpose of Financial Statements is adapted from “Accounting summarised in the financial statements” from Accounting and Accountability Copyright © by Amanda White; Mitchell Franklin; Patty Graybeal; and Dixon Cooper is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike 4.0 International License, except where otherwise noted.
