What is the purpose of balance sheet analysis? Economics summary on the fundamental concepts: the purposes and postulates of balance sheet.
BALANCE SHEET ANALYSIS: SUMMARY
The general rules that must be followed in the preparation of the financial statement are called ” balance sheet postulates ” and are indicated in the civil code starting from art. 2423.
Article 2423, paragraph I of the Civil Code establishes that: ” The directors must draw up the financial statement, consisting of the balance sheet, the income statement and the explanatory notes “.
Article 2423, paragraph II of the Civil Code also establishes that: ” The balance sheet must be drawn up clearly and must represent in a true and correct manner the financial and equity situation of the company and the economic result of the financial year .”
BUDGET POSTULATES: CLAUSES
In this paragraph appear two fundamental principles, which are called ” general clauses of the budget postulates “, and that is:
- the postulate of clarity , which must be understood as:
– obligation to comply with the balance sheet schemes indicated in the subsequent articles of the civil code;
– prohibition of grouping items that may damage the clarity and comprehensibility of the balance sheet, the items can be grouped only when their amounts are irrelevant in order to make the reading of the balance sheet clearer and more immediate, but in this case the various separate amounts must still be indicated in the explanatory notes;
– prohibition of compensation of items, in the sense that compensations must not be made between balance sheet values of opposite signs unless this is explicitly permitted by law; - the clause of true and fair representation , which should not be understood as an obligation to report the values in an objective and absolutely precise manner, but simply as the obligation to comply with the provisions of the law when making estimates of the various budget items.
BUDGET POSTULATES: DRAFTING PRINCIPLES
However , among the budget postulates there are not only the general clauses, but also the drafting principles , that is:
- principle of prudence and recording of profits actually achieved : presumed losses must be considered, while profits expected but not yet achieved must not be taken into consideration, in order to avoid distributing profits that may not even be achieved;
- principle of continuation of business activity : the evaluations of the various elements of the balance sheet must be carried out starting from the assumption that the business activity continues regularly beyond the end of the financial year;
- principle of economic competence : the costs and revenues accrued during the financial year must be recorded in the balance sheet regardless of when the actual payment or collection of the debt or credit will occur;
- consideration of the risks and losses pertaining to the financial year , even if known after the closing of the financial year but before the approval of the budget;
- principle of separateness : the different elements which, when added together, lead to the determination of the value of each balance sheet item must be evaluated separately and then added together, to avoid that an overall evaluation could cause the sum of presumed losses and hoped-for profits which, as we know, should not be considered;
- principle of constancy : the criterion followed for the estimate of the various items of the balance sheet must remain the same from one year to another, when it is changed the reason for the change must be explained in the explanatory notes.