Financial statements are prepared by every company to gauge its performance, to report its performance to its shareholders and to comply by regulatory requirements. Though, financial statements provide wealth of information, but it has loads of shortcomings.
- Financial statements rely everything on book value. They never give you a reflection of market value. They never tell you about the market value of assets it holds. Suppose, a company buys a fixed asset like land or building, it always gives the numbers in terms of original or historical cost. It never tells you the present market value of that particular asset. Thus, for every asset, it always gives you the book value. It never gives you the market value.
- Financial statement records the cost of the "bought" assets by the company in its statements. But it never records assets created by efforts of the company. For example, a company never records the value of the product or patent created by its Research and Development, though it'll record the value of a bought patent in its financial statements.
- Financial statements categorise expenses as operating, financial and capital expenses. Financial statements often err while categorising a particular expense. For example, expenses made on fixed assets are considered as capital expenses by a company and are depreciated or amortised over a period of time. Patents are also assets, but expenses made on its R&D are considered as operating expenses. Similarly, operating leases are also considered as operating expenses which rather should be considered as financial expenses.
- Financial statements report the assets on which investment has been already made, but they never tell us about assets on which investment is to be done. This later investment will open new growth avenues for the company. For example, fruits of R&D and patents can be considered as such assets.
- Like assets, financial statements don't reflect the market value of liabilities, like debt and shareholders' equity. They simply reflect the book value as usual.
- While financial statements are geared towards finding whether a company will be able to meet its obligations of debt and payments to suppliers, they don't throw any light on risk to equity investors.
