Limitations of financial statements

1.    Financial statements are available only after the specific period of time is over e.g. the balance sheet as on 31st March, 1990 is available only after 31st March, 1990 is over. The various legal provisions also provide for sufficient time lag for the preparation of financial statements. Thus, the financial statements give the information about the historic facts which may not be sufficient from decision making point of view for the management.

2.    Financial statements are necessarily intern reports and cannot be final ones. To understand the correct profitability and to understand the correct position of various assets and liabilities, it will be necessary to stop the business operations and dispose off all the assets and liquidate all the liabilities which may not be practicable and feasible. In order to prepare the financial statements for a specific period, it may be necessary to cut off various transactions involving costs and incomes at the date of closing the accounts which may involve the personal judgements. Various policies and principles are required to be formulated and followed consistently for such cutting and off of incomes and costs.

3.    As going concern principle is followed while preparing the balance sheet, the various assets and liabilities are shown at historical prices and do not necessarily represent the current market prices or the liquidation prices. This may affect the profitability statements as well in form of incorrect provision for depreciation. This problem may be more critical during the periods of extreme inflation or depression. As such, any conclusions drawn on the basis of such financial statements may be misleading ones.

4.    financial statement consider only those transactions which can be expressed in a monetary terms. All other transactions or factors which cannot be expressed in terms of money are ignored by the financial statements. Assuming that the business of a company is such that it is likely to be injurious to the health of local community. As such, there is a strong opposition from the local community for the company’s carrying on of business at that location. This opposition is something which cannot be expressed in terms of money and hence finds no place in the financial statements thought it is affecting the business operations of the company to a great extent.

5.    The financial statements prepared may be useful for the use of normal users under normal circumstances. If a user wants to use the financial statements for some special purposes, the necessary information or details may not be available from the financial statements. If a user, on the basis of financial statements available wants to value the equity shares of the company with the methods considering earnings capacity of the company, the required details may not be available from the financial statements. Similarly, the financial statements may not give correct indications about the profitable or the financial conditions of the business under abnormal circumstances. Suppose that the production and sales of a company in a particular year are abnormally high due to prolonged strike in one of the major competitor companies, and hence profits are at normal level, the performance of that year may be treated as bad as compared to abnormal year.

6.    Financial statements, howsoever carefully and correctly prepared, do not mean anything all by themselves unless the information stated therein is properly studied, analyzed and interpreted. As such, merely the preparation of financial statements is not sufficient, equally important is the task of their analysis and interpretation.

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