Explain why different businesses prepare financial statements
Connect the purpose and limits of financial statements to the organisation that prepares them and the people who use the information.
Exam scope and assessment notes
Cambridge International AS & A Level Accounting 9706, 2026–2028 syllabus, Version 2. These original lessons map all five Topic 3.1 objectives: financial-statement purpose; partnership changes; clubs and societies; manufacturing accounts; and limited-company financial statements and notes. Practice is self-checked, not an official Cambridge grade. Full timed Papers 1–4 and human subject-teacher review remain outstanding.
Before you begin
- Use the Topic 1.5 adjustment and statement skills: apply accruals, distinguish capital from revenue, reconcile balances, and keep each entity's owners' funds separate from income and cash.
Work on paper. Try each question before revealing help, and explain why your method works.
Quick readiness check
Which statement reports financial performance over an accounting period?
What you will learn
- Explain why a business prepares financial statements
- Relate statement information to owners, lenders and other users
- Distinguish general-purpose reporting from internal management information
Statements report performance and position
A statement of profit or loss reports financial performance over a period; a statement of financial position reports assets, liabilities and equity at a date. A statement of cash flows explains cash movements over a period. Together, they support stewardship, accountability and decisions, but they answer different questions.
A sole trader's statements help the owner assess profit, resources and obligations. Partnership statements also show how profit and equity relate to partners. A limited company's statements report on a separate legal entity for shareholders, directors, lenders and other users. Clubs and societies report stewardship of members' funds and whether activities produced a surplus or deficit.
Useful information still has limits
Financial statements summarise recorded transactions using accounting policies and estimates. They can support comparisons and decisions, but do not establish future success, unrecorded social value, product quality or every user's information needs. Users should consider context, notes, timing and non-financial evidence.
Management accounts are prepared for internal planning and control and can be tailored to managers' decisions. Published financial statements are more general-purpose and follow relevant reporting requirements. Do not treat a cash surplus as profit or assume that a profitable business necessarily has enough cash to pay every bill on time.
Pause and explain
A company reports profit but has little cash at year end. Which statement best explains cash movements?
Worked example
A lender is considering a three-year loan to a limited company. Which statements and information help the lender assess repayment capacity, and what cannot they guarantee?
Show the worked solution
- Use the cash-flow statement to examine cash generated and used over the period.
- Use the statement of profit or loss to assess reported performance and the statement of financial position to inspect debt, assets and equity at a date.
- Consider the notes, loan terms and recent trends; historical statements cannot guarantee future cash flows.
Answer The lender can use all three statements and their notes to assess historical performance, liquidity and financial position. They inform a lending decision but cannot guarantee future cash generation or repayment.
Try a topic test
Choose Easy, Normal or Difficult. Save your answers and open worked review after finishing.
Test this topic →From guided practice to a new situation
Write your answer and reasoning first. Use a hint only if you are stuck. The model solution is for self-checking; your written work is not automatically marked.
A members' club wants to show whether its year of activities was financially sustainable. Which report is most directly relevant, and which report answers a different question about cash?
Give me a hint
Separate accrual-based performance from cash received and paid.
Compare my reasoning
- An income and expenditure account recognises income and expenses for the period.
- A receipts and payments account summarises cash received and paid.
- A surplus or deficit is not automatically the change in cash because accruals and non-cash items may differ.
Use the income and expenditure account to assess the period's surplus or deficit. Use the receipts and payments account to summarise cash movements; they answer different questions.
Look for these in your work
- Performance report named
- Cash report distinguished
- Accruals considered
A supplier is deciding whether to allow a company 60 days' credit. Give two useful statement-based indicators and one limitation of relying on them.
Give me a hint
Combine short-term payment capacity with performance or position, then identify a forward-looking uncertainty.
Compare my reasoning
- Inspect current assets and current liabilities on the statement of financial position.
- Review cash flows and recent operating performance for evidence of cash generation.
- The statements are historical and may omit current order cancellations or a sudden change in customer payments.
The supplier can review liquidity, cash flows and performance, alongside the notes and payment history. These are historical summaries and cannot guarantee that the company will have cash when the invoice falls due.
Look for these in your work
- Liquidity evidence used
- A second relevant source used
- A limitation stated
A charity-like society has a large cash balance after receiving a restricted building donation, but its ordinary activities made a deficit. Explain why a member should look beyond the cash balance before judging sustainability.
Give me a hint
Separate the source and permitted use of cash from recurring activity performance.
Compare my reasoning
- The cash balance includes a restricted receipt that may only be used for the building.
- The income and expenditure account shows whether ordinary period income covered ordinary expenses.
- Review restrictions, commitments and future operating receipts before concluding that routine activity is sustainable.
The cash balance is not all available for ordinary spending if a donation is restricted. The member should inspect the income and expenditure account, fund restrictions and future cash needs before judging sustainability.
Look for these in your work
- Restricted cash identified
- Operating performance considered
- Conclusion is evidence-based
Common mistakes
- Treating profit as the same thing as cash
- Assuming historical statements guarantee future performance
What can you explain now?
Which statement reports assets and liabilities at a particular date?
Compare with the explanation
The statement of financial position
It presents assets, liabilities and equity at a reporting date; profit and cash-flow statements cover periods.
After trying it yourself, choose your next review. This is your self-assessment.
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Make it stick
In one sentence each, state what the statement of profit or loss, statement of financial position and statement of cash flows report.
If you needed the solution, close it and solve the problem again from a blank page. A correct answer is stronger when you can explain the reason for each step.