In this article, we cover the purpose of operating statement. This includes the overview of operating statement as well as each type of operating statement. Then, we will go further to the purpose of each operating statement.
So let’s go through together!
There are five financial statements that businesses prepare to document and demonstrate their performance and position after a certain period. These financial statements include the Statement of Financial Position, Statement of Profit or Loss, Statement of Cash Flows, Statement of Owners’ Equity or Statement of Stockholders’ Equity and Notes to the Financial Statements although, some may not consider Notes as a separate financial statement. There are many reasons why businesses prepare financial statements. Most importantly, the stakeholders, especially the owners of a business, require the financial statements to make decisions related to their relationship with it. Similarly, financial statements may be required under some rules and regulations, therefore, making their preparation crucial.
Basically, we consider the Statement of Financial Position and Statement of Profit or Loss as the main financial statements. That is because these financial statements usually have enough information for users to make their decisions. Most jurisdictions require businesses to prepare only these two financial statements, along with the related notes. However, the Statement of Cash Flows and Statement of Owners’ Equity also has some advantages.
There are two operating statements that business prepares for a specific period, namely the Statement of Profit or Loss and the Statement of Cash Flows. Unlike the Statement of Financial Position or the Statement of Owners’ Equity, operating statements do not focus on balances that are carried over or brought forward to the accounting period the statements are prepared for. Instead, operating statements are prepared for a single period with comparatives of the previous period.
Statement of Profit or Loss
The Statement of Profit or Loss is one of the two most important financial statements for a business, the other one being the Statement of Financial Position. Some stakeholders such as investors or owners may consider the Statement of Profit or Loss even more superior to the Statement of Financial Position, as it gives valuable insights to the performance of a business for a particular period. The Statement of Profit or Loss, as the name suggests, is a financial statement that shows whether a business has made a profit or a loss for a particular period.
However, the Statement of Profit or Loss isn’t just about the profit or loss of business. It also contains a detailed account of the revenues and expenses of the business. The statement starts with taking the revenues of the business and deducts all of its expenses from revenues to reach the Net Profit of the business. However, it may also contain some other types of profits such as Gross Profit or Operating Profit (also known as Earnings before Interest and Tax) of the business. While the profit of a business shows the summary of its operations, the revenue and expenses reveal much more.
The revenues of a business, presented in the Statement of Profit or Loss, is the main indicator of the performance of a business, after its profits. Usually, the higher the revenues of the business are, the higher profits it will make. Revenues are also important because they show the ability of the business to generate income. Similarly, higher revenues also indicate the efficiency of a business in using its resources properly. If a business cannot generate revenues despite high capital, it is likely going to be criticized by stakeholders.
Similarly, the expenses of business also play a vital role in its profits. Usually, the lower the expenses of a business are, the higher its profits will be. The Statement of Profit or Loss also helps businesses and stakeholders identify any expenses that are particularly high and affect their profits negatively. Businesses usually focus on reducing their expenses, as they can easily be controlled. This is different from revenues, which can be affected by external factors.
Statement of Cash Flows
While the Statement of Cash Flows does have opening and closing balances of cash and cash equivalent balances, it is more focused on the performance for the specific period rather than balances. The Statement of Cash Flows summarizes the cash inflows and outflows of the business for the period. There are two methods use to prepare the Statement of Cash Flows, direct method and indirect method. However, the indirect method is more common among businesses.
The Statement of Cash Flows categorizes cash flows into three main components. These three components are cash flows from operating activities, cash flows from investing activities, and cash flows from financing activities. Cash flows from operating activities generally consist of all cash flows generated as a result of the operations of the business. Cash flows from investing activities consist of cash flows generated or spent on investing activities such as investing in subsidiaries or investing in fixed assets. Finally, cash flow from financing activities consists of cash flows relating to how a business generates finance, such as investment from owner or loans from a bank.
Some stakeholders may not consider the Statement of Cash Flow as a main financial statement. Similarly, under some jurisdictions, small businesses may not be required to prepare them either. However, just like the profit of a business, its cash flows and how it manages them is a point of interest for most stakeholders. That is because the statement can provide some useful insights into the ability of the business to manage its cash flows efficiently and effectively.
What is the purpose of operating statement?
As a whole, the purpose of operating statements is to exemplify the performance of the business for a particular period. The Statement of Profit or Loss shows the financial performance of the business while the Statement of Cash Flows shows its cash management performance for the same period. Both of these are periodic statements. Therefore, they also illustrate the performance of the business from one period to another. Individually, the purpose of both statements is different. It is, therefore, better to look at them individually.
Statement of Profit or Loss
The main purpose of the Statement of Profit or Loss is to tell its user how much profit or loss a business had generated during the reporting period. Statement of profit or loss is one of the most important financial statements for any business. That is because the Statement of Profit or Loss is one of the most favorite financial statements of investors and owners. The statement also provides a comparison with the historical performances of the business, which stakeholders can use for better decision-making.
The Statement of Profit or Loss also gives users several subtotals such as Gross Profit and Operating profit that can help users understand different aspects of the performance of the business. The Gross Profit of business demonstrates its ability to generate profits from only the products or services it is selling. Operating profit, on the other hand, describes the ability of a business to generate profits from its operations. These are both important indicators of the performance of a business as well.
The purpose of the Statement of Profit or Loss differs according to the needs of the user. For example, the owner of a business or an investor would use the statement to determine whether the business is profitable enough for them to invest in. While for a financial institution, for example, a bank, that has given a loan to the business, the Statement of Profit or Loss may be an indicator of the ability of the business to generate enough profit to pay off their interests.
Statement of Cash Flows
The purpose of the Statement of Cash Flows is to identify and present any major cash flows of the business to its user for a particular period. Furthermore, the purpose of the statement is to classify the cash flows of the business into three main categories, operating, investing and financing activities.
By classifying cash flows based on their source, the Statement of Cash Flows allows users of the financial statements to easily determine where most of the cash flows of a business are generated and used. Similarly, the investing and financing activities categories allows users to track any special transactions that occur within the business. This is because investing and financing activities are very impactful but rarer as compared to operating activities. By comparing the information related to cash flows with previous years, users can easily determine any irregular cash flows that can give them extra information related to the business.
Finally, the purpose of the Statement of Cash Flows is also to present the actual cash flows rather than accrued expenses of a business. This can be helpful for users who want to determine how much actual taxes, interests and other obligations a business has paid. This information is not available in the other financial statements of a business, thus, making the Statement of Cash Flows more important for users.
There are five main financial statements that businesses prepare. Among them, two are known as Operating Statements, namely the Statement of Profit or Loss and the Statement of Cash Flows. Operating statements are prepared for a specific period and do not focus on balances like the other two financial statements. The purpose of operating statements is to give users an insight into the performance, either financial or cash, of a business for a particular period. However, both the operating systems may have their purposes.