Financial Reporting

Financial reporting is the process of producing statements that disclose an organization's financial status to management, investors and the government.

In the United States, the four basic reports are balance sheets, income statements (also referred to as profit and loss statements), cash flow statements and statements of shareholders' equity.

A financial report, also often referred to as financial reporting or annual report, is a large collective document that summarizes the financial spending and earning of a given business over the duration of a single year. It combines both the earnings of the income statements, provides an overlook of the net worth and shows the business’ spending and expenses in great detail.

All companies engage in financial reporting. Some companies create elaborate financial presentations for the investors and lenders. Others produce basic financial statements for the owner. Financial reporting allows the company to share its activities during the period. Financial statement readers learn about the company's profitability and how it balances its debt financing with equity financing. Financial reporting meets several objectives.

Communication. One objective of financial reporting involves communication. Several individuals hold a vested interest in how a company performs. These individuals learn about the company’s performance by reviewing the financial statements. The income statement communicates the company’s profitability. The balance sheet communicates the company’s ability to obtain and invest its resources. The statement of cash flows communicates the company’s ability to manage its cash. Companies communicate the financial results by mailing financial statements and by publishing them on the company website.

Solicit Investors. Another objective of financial reporting considers the company’s ability to attract new investors. Investors try to predict which companies will provide the best return for their money. Investors request copies of the company’s financial statements. They review the numbers reported on each statement and compare those results with the numbers on other companies’ financial statements. Companies issue financial reports that share their past financial results and express their future plans. They present their future plans as a way of communicating their ability to grow the company.

Demonstrate Creditworthiness. Financial reporting allows the company to demonstrate its creditworthiness to lenders and creditors. Creditors sell products and services to the company and allow the company to pay for them at a future date. Lenders give money to the company in exchange for the promise to repay that money in the future. Lenders and creditors use the company’s financial reports to evaluate whether the company can repay the money borrowed.

Compliance. Compliance represents another objective of financial reporting. The Internal Revenue Service requires corporations to report their financial results on their income tax return. Sole proprietors report their financial results on their personal income tax return. The Securities and Exchange Commission requires publicly traded corporations to file their financial statements quarterly. These companies report their financial results to remain compliant.

The Objective of Financial Reporting

The main objective of financial reporting is to provide financial information to current capital provides to make decisions. This information might also be useful to users who are not capital providers. The general purpose financial reporting develops superior reporting standards to help in the efficient functioning of economies and the efficient allocation of resources in capital markets. General purpose financial reporting focuses on an extensive range of users’ needs that lack the ability to obtain financial information needed from the entity. It should be broad enough to comprehend information for the various users. Therefore, the financial report is where they depend on to acquire information. Diverse users may require different information which might go beyond the scope of general purpose financial reporting. 

The financial reports are prepared from the entity’s perspective (deemed to have substance on its own, spate from that of its owners), instead of the entity’s capital providers. An entity attains economic resources (its assets) from capital providers in exchange for claims to those resources (its liabilities and equity). Capital providers include;

1. Equity investors:  Equity investors normally invest economic resources in an entity expecting to receive a return on, as well as a return of, the resources invested in. Hence, equity investors are concerned with the amount, timing, uncertainty of an entity’s future cash flows and the entity’s competence in generating those cash flows which affects the prices of their equity interests. Furthermore, they are concerned with the performance of directors and management of the entity in discharging their responsibility to make efficient and profitable use of the assets invested.
2. Lenders:  Lenders usually expect to receive a return in the form of interest, repayments of borrowings, and increases in the prices of debt securities. Lenders have similar interests as the equity investors.
3. Other creditors:  Other creditors provide resources because of their relationship with the entity, instead of a capital provider; no primary relationship.
• Employee – salary or compensation
• Suppliers – extended credit
• Customer – prepay for goods and services
• Managers – responsible for preparing financial reports

Capital providers make decisions through useful information provided in financial reporting by particular entity. Financial reporting usefulness in assessing cash flow prospects depends on the entity’s current cash resources and the ability to generate sufficient cash to reimburse its capital providers. Besides, financial reporting usefulness in assessing stewardship includes the management’s responsibilities to protect the entity’s economic resources (assets) from unfavorable effects. Management is also liable for safeguarding the assets of the entity which conforms to the laws, regulations and contractual provisions; thus, the importance of management’s performance in the decision usefulness.

The general purpose financial reporting is limited to information which does not reflect pertinent information from other sources that should be considered by the users. Financial reporting information is based on estimates, judgments, and models of the financial effects on an entity of transactions and other events in which, is only ideal for preparers and standard setters to strive. Achieving the framework’s vision of ideal financial reporting to the fullest will be difficult in the short term because of technical infeasibility and cost constrains.

Financial reporting should include information about: the economic resources of an entity (assets), the claims of the entity are (liabilities and equity), the effects of transaction and any events or circumstances that can affect the entity’s resources and claims and provide useful information about the ability of entity to generate its cash flow and how well the entity meets its management responsibilities.

The usefulness of financial reporting to the users:

1. Provide useful information about the amount, timing, and uncertainty of future cash flow
2. To identify the entity’s financial strengths and weaknesses (especially for capital providers)
3. To indicate the potential of entity’s cash flow for its economic resources and claims
4. To identify the effectiveness of the entity’s management responsibilities
5. To assess availabilities of the entity’s nature and quantity of the resources for the use in its operation
6. To estimate the values of the entity.

The quantitative measures and other information regarding the changes in entity’s economics resources and claims in the financial report can help the users to assess the amount, timing, and uncertainty of its cash flow; and indicate the effectiveness of management responsibilities.

Furthermore, the entity must provide a positive return on its economic resources in order to generate net cash inflows; and return the earning to its investors. Other information like variability of returns, past financial performance, and management’s ability can be used to assess the entity’s future financial performance.

The entity’s cash flow performance in financial reporting assist the investors to understand the entity’s business model and operation through assessing how the entity obtains and spends cash. Information about its borrowing, repayment of borrowing, cash dividends and other distribution to investors, as well as the factors of entity’s liquidity and solvency, can also assist the investors to determine the entity’s cash flow accounting.

Besides, information about the changes of entity’s resources and claims not resulting from financial performance may assist the investors to differentiate the changes that are results of the entity’s financial performance and those that are not.

The information of management explanation should be included in financial reporting to assist users for a better understanding about management decision in any events and circumstances that have affected or may affect the entity’s financial performance. It is because the internal parties know about the entity’s performance than the external users.

 The Objectives of Financial Reporting by Business Enterprises

A common reason small companies fail to reach their profit potential or eventually go out of business is poor financial reporting. It's not enough to know what your sales are, how much money you have in the bank or what your expenses are if you want to maintain operational efficiencies that create stable cash flows and long-term profits. Creating a financial reporting system will help you set policies, monitor your activities and generate your profit potential.

Depending on the size and type of business, financial reporting has different meanings and uses. At nonprofits, the term includes disclosing sources and uses of funds, officer and key employee salaries and other financial information to the public. At small businesses, financial reporting provides managers with a variety of ongoing reports that let them understand how each area of the business's operations affects the company's bottom-line performance; the reports also allow managers to create and monitor budgets and to plan long-term business strategies. At publicly traded companies, financial reporting refers to the public dissemination of data for scrutiny by stakeholders such as shareholders, the Securities and Exchange Commission and the media.

Helps with Pricing

Financial reporting helps companies set optimal prices. Financial data for your business should include the calculation of your overhead and production expenses at different levels so you can see how different sales volumes will affect your costs. Knowing this, you can effectively set your prices. A financial report that shows you the cost of sales for different distribution methods, such as selling online, using a print catalog or in a retail store, will help you set prices for using those methods.

Reduces Cash Flow Problems

A typical budget shows when you expect to make a sale and the cost for that sale, often recording both figures in the month when the sale is expected. This can cause cash shortfalls, because you might not receive payment for that sale for 30 or more days, while your expenses to fulfill the sale come before that. A key financial report for any business is a cash flow report, which shows when you will receive money and when you must pay bills, debts, taxes or other obligations. This report helps you plan your cash reserve and credit needs.

Effective Production and Labor Planning

Knowing your production and labor costs will help you better schedule your production and worker needs, avoiding large spikes in expenses you might have otherwise spread out had you known about potential problems. If you know that a large order might increase your costs because you need to add temporary workers, pay overtime, increase training or add a shift, you can take steps to make part of that order earlier, reducing your labor costs with better scheduling.

Improved Cost Containment

Knowing exactly how much you spend on overhead and production will help you track your spending and spot areas where you can cut costs to maximize profitability. For example, you might not realize how much credit card interest is cutting into your profits. Having that information might spur you to use some of your excess cash to pay down debt and increase your profits.

Better Money Access

When you apply for credit, lenders often want internal financial reports, rather than just a bank statement. A bank statement might show $25,000 in your account, but a balance sheet, which is a list of your assets and liabilities, might show your net worth is actually negative. The ability to show potential lenders, investors and creditors your cash flow, net worth and receivables might be the difference between getting their money and not.

Financial Reporting Vs. Financial Statements

The terms “financial reporting” and “financial statements” are often interchanged in the workplace. Both terms have some similarities, but financial reporting encompasses a much broader and detailed definition. Both the financial report and the individual statements play a role in creating the annual financial data report that investors and shareholders read as part of their financial research.

Financial statements are short documents that present the income information for a business at any given point in time. The financial information will show a current balance sheet in terms of income, changes in the overall worth of the company based in income and a cash flow statement that shows where the funds are coming from. A financial statement does not include information about expenses or purchases.

Using Reports and Statements

Financial statements provide financial data and information on the spot. Financial statements are therefore generated several times throughout the year to provide accountants and financial advisors and planners within the business with financial information, so they can plan and budget accordingly. Once a year, normally at the end of the fiscal year, all of the financial statements are added up to create the income information for a financial report. Since the financial statements only provide the income of the business, the creator must gather the expense information from purchases and expense budgets to complete the financial report.

Investors, Shareholders and Stockholders

Company owners use the financial reports as a method of attracting potential investors, shareholders and stockholders to the business. Since the financial report is a compilation of several financial statements for a given year, the investors and holders are able to see the changes in the company’s net worth, statements in cash flow and an operational balance sheet. In other words, the investors are able to track all of the funds and cash within the business and identify how and where it is being spent and earned.

Dangers of Inaccurate Financial Reporting

Financial reporting is the catchall term covering everything from your company's cash-flow statement to financial information in press releases. Anything you tell stakeholders, regulators or the public about your finances falls into this category. If your reporting is inaccurate, that can lead to legal trouble, stock prices dropping and bad company decisions.

Investors rely on financial statements to assess a company's worth, while management relies on internal financial reports for sound decision making. Inaccurate reports can lead you to make bad decisions or make your company look less valuable than it is. They can also land you in legal hot water.

It also includes footnotes on the statements that provide more information about specific topics. In addition, your shareholder reports, any investor prospectus and whatever financial information you post on your website also count as financial reporting.

If your stock is publicly held, you have a few more reporting categories:

• Forms 10-Q and 10-K, which you file with the Securities and Exchange Commission
• Press releases containing financial information about the company
• Earnings calls in which management discusses corporate finances

Most financial reporting follows an established accounting standard such as Generally Accepted Accounting Principles (GAAP). The Securities and Exchange Commission’s requires financial statements from publicly traded companies conform to GAAP, Business News Daily says. Following GAAP doesn't guarantee the statements are accurate, so companies also have to undergo annual audits.

How Financial Reporting Goes Wrong

Companies sometimes commit fraud in their financial statements, misrepresenting the company's financial health to impress investors or hide taxable income. However even a 100 percent ethical business can screw up their reports, Financial Management says. It's not just a matter of mistakes: Not reading or analyzing your bookkeeper's reports means you're not getting much use of them.

• The reports lack comparative data showing, for example, how this quarter compares to last quarter or how actual spending compares to the budget.
• Reports that do include comparative data leave it to the readers to interpret. A report that shows monthly sales revenue for the past year but doesn't translate the differences into percentage requires the readers to make the calculation. They're more likely to get it wrong or misinterpret what they're reading.
• Your bookkeeper doesn't follow GAAP. For example you and the bookkeeper know one of your customers won't pay up, but you keep that knowledge in your heads instead of adjusting accounts receivable.
• You receive internal financial reports, but you don't read them. You can't spot any discrepancies or oddities in the bookkeeping if you don't look for them.
• You read the reports, but don't analyze them. If there are negative trends such as accounts receivable taking longer and longer to pay, you need to spot them before you can identify the problem.
• Not monitoring cash flow closely. Even if your income is good, poor cash flow means you can't pay your bills. Your accounting team needs to update the cash-flow statement even more frequently than other forms of financial reports.

Risk Management says even though large companies often use automated systems to track and record data, the systems can still generate inaccurate reporting. Multiple people making multiple data entries, sometimes in multiple systems, creates errors and inconsistencies. It's not always easy to identify the source of the data and verify its accuracy.

Bad judgment is another issue. Even under GAAP, some issues aren't purely a matter of crunching numbers. Figuring how to expense R&D or to value your company's goodwill are among the many matters that require judgment calls. Those calls won't always be right, particularly close to the end of an accounting period when everyone's rushing to close the books.

Consequences of Bad Reporting

One consequence of bad reporting, Risk Management says, is wasted time. With a lot of human error and data flowing in from multiple sources, your finance department may have to spend hours or days each quarter reconciling financial data throughout your organization. That can add up to a lot of salary spent fighting financial-reporting fires.

Another consequence is that inaccurate information in internal reports makes it harder to make good decisions. Companies rely on financial data in budgeting, forecasting and developing performance indicators. If sales metrics and R&D numbers are off, even if they don't actually violate GAAP, your projections and budgets may be off, too. If your reports understate your debt load, you may discover you're deeper in the red than you thought.

Micronet says misinformation in reports can leave you blind to problems where accurate reports would have been a red flag. Errors can also hurt in other ways until they're corrected: Exaggerated profits can lead to higher taxes, while underestimated profits make your company looks less valuable.

If you issue a statement of earnings, then have to restate them later because of errors, that's not good either. Your stock price may drop, your reputation takes a hit and it may become tougher to obtain capital. There's also the risk that the errors in your reporting are material enough to violate GAAP. If you're a CEO of a publicly traded company, you have to sign off on the accuracy of your financial statements. It's better if the SEC doesn't discover major problems after you've signed.

In 2019, for instance, the SEC said Hertz would have to pay $16 million in penalties, a decision the car rental company signed off on. SEC said Hertz' accounting decisions had been driven by a desire to meet budgets and earning estimates and included multiple misstatements of material facts. Hertz did not admit to any errors, but agreed to pay the penalty.

Consequences of Bad Auditing

External audits are one tool for keeping your financial reporting in line with reality, Inc_._ says. In a financial statement audit, the outside auditor reviews your statements to see if they comply with GAAP standards. That includes checking that your internal controls to prevent errors and fraud work as they're supposed to.

Several audit scandals in the 21st century have demonstrated that auditors don't always do the job right, Strategic Finance says. Some accounting firms have found the real money is in consulting and advising business, and the desire to win clients creates an auditor bias against criticizing them. Where elements of financial reporting are based on C-suite opinions, auditors may end up deferring to management's judgment instead of scrutinizing it.

The consequences of audit failure can be severe. If auditors don't catch inaccuracies in your financial reporting, the problems may grow catastrophic, steering a company to collapse. Unacknowledged liabilities can build up until dealing them becomes a serious problem, even if the company survives.

Important Financial Report for a Small Business

When starting out a small business, entrepreneurs may find it quite confusing to determine which reports are important and how to read these financial reports. There are three basic reports that a small business requires to keep track of its finances: the balance sheet, the income statement and the cash flow statement. The cash flow statement is arguably the most important of a small business' financial reports. This report essentially indicates if the business is generating cash, or not.

Complementary. The balance sheet indicates a company's assets, liability and net worth, and is not intricately concerned with the daily operations of the business. The income statement comes closer to the cash flow -- it shows whether the business has made a profit or a loss, taking into account the total revenues less the total expenses. The cash flow breaks down the information in the balance sheet and income statement into simpler data. This simpler data provides a snapshot of how well the business is doing.

Purpose. A small business uses cash flow statements to report the inflow and outflow of the business. The inflow is the cash or revenues that come into the business through the sale of commodities; the outflow is the cash used in the daily operations of the business. This inward and outward flow of cash is important to keep a business in operation. Without sufficient inflow, then the business will lack cash to pay for expenses and to purchase inventory or stock.

Frequency. How often should a small business manage its cash flow statement? A small business owner should report his cash flow on a monthly basis. This is because most small businesses purchase inventory and pay for expenses on a monthly basis. Due to the crucial role it plays in a business, it is important not to neglect reporting and accounting for cash flow. This is especially true because small businesses experience hardship in raising and generating cash as they start up.

Components. The cash flow statement has three components. The first part constitutes a business' cash flow from its operations; the business accounts this as the net income less the operational costs. The second part constitutes cash flow generated from investment activities, which entail purchase of assets for the business, such as equipment; the business records this as an outflow. Third, are the financial activities which constitute cash flow from bank loans or venture capital, and is recorded as outflow when paying it back.

General Purpose Financial Report

An employee may be asked to complete a general purpose financial report. This report is one that broadly shows the financial information pertaining to the business in question and is designed to be offered to all types of readers, not a specific group. When composing this type of report, an employee needs to know what it is commonly used for and what information goes into writing it correctly.

A general purpose financial report is a general report that shows all of the financial information that pertains to a business. This is done to meet all of the needs of the readers, rather than those of a specific group of readers, such as investors, shareholders, business executives or budget planners. The name, general purpose financial report, indicates the report is a general observation of the company’s finances.

Sections

Common sections in a general purpose financial report include income statements, which cover income from investors and sales, cash flow statements, which cover all of the operational expenses the business has in order to operate and a balance sheet that shows how much the business owns as assets and how much it owes in liabilities.

 Offer Totals

Total estimates of various sections, such as expenses, assets and liabilities, also are offered in the general purpose financial report. For example, the company may have a long list of monthly expenses, which is needed to operate the business to its full potential. Instead of listing all of the expenses on several pages, the general purpose financial report offers total sums, so readers can see exactly how much is being spent each month.

Uses

There are numerous readers for a general purpose financial report, which means that it has several purposes. Shareholders and investors may analyze the information and data in the report to determine how the business is doing financially and whether investments made in the business are wise investments. If the report reaches the public, the public may read the report to see how the business is spending its money internally and to see how much the business is earning on products or services. Business executives may analyze the general purpose financial report to see if any changes need to be made to the budget to eliminate liabilities or cut expenses.

Financial Reporting Requirements and Regulations

Financial reports for private and public companies based in the U.S. must follow the Generally Accepted Accounting Principles (GAAP), while most international companies report under the Internal Reporting Financial Standards (IRFS). While both accounting frameworks provide standard rules and guidelines, there are slight differences between the two financial reporting systems.

Although the IFRS is still in development, the general consensus is that it allows international companies to issue short, clean, and reader-friendly financial reports. The U.S. GAAP requires financial reports to be much more thorough and follow a unique set of rules and guidelines. 

There are several initiatives to either merge the two frameworks or simply reduce their differences. Despite these distinctions, both systems provide a standard framework to make financial reports accurate and consistent across the board. 

Understanding the Importance of Financial Reporting

Without financial reporting, it’s difficult to understand how well a company is performing from a financial standpoint. Not only are financial reports crucial for management or investors to assess a business’s financial stability, but they are required by law for taxes and standard accounting practices. Here are the top reasons financial reporting can benefit your small business:

Make Better Financial Decisions. Analyzing and understanding financial statements is key when a business needs to make an important decision. Financial reports allow management to identify trends, potential roadblocks, and actively track their financial performance in real-time. Staying on top of your financial statements will give you the foundation you need to make quick and sound economic decisions when the time comes.

Manage Debt. Financial statements provide business owners and management direct insight into their company’s current assets and liabilities. Also, on how they should effectively manage their company’s outstanding debt moving forward. 

Simplify Your Taxes. Financial reports are required by law for tax purposes and the Internal Revenue Service (IRS) uses these reports to evaluate a company’s tax income. Accurate financial reporting mitigates the risk for error and saves an immense amount of time. It relieves the overall burden that comes along with filing your company’s taxes each year.

Compliance. It’s no secret that accurate financial reporting can improve your company’s financial performance but it also guarantees that your business is compliant with the law and regulations required by government agencies such as the IRS and SEC. 

Financial Transparency. External stakeholders must research a company’s financial position before they decide to officially invest. Financial reporting is a great way to showcase a company’s financial integrity and build trust with potential investors and creditors.