All businesses engage in some form of financial reporting. At the very least, most companies prepare monthly profit and loss (P&L) and cash flow statements to assess business performance. Other organizations, especially those that use enterprise resource planning (ERP) and enterprise performance management (EPM), have more detailed reports.
Financial reporting has become a standard part of conducting business. However, have you ever wondered why this is the case? Why are there so many reports, and what value do they bring?
In short, what is the real importance of financial reporting? The ways in which financial reporting benefits businesses are not always obvious. Here’s a quick look at some of the most important reasons financial reporting is critical to any business.
What Is Financial Reporting, Exactly?
Financial reporting involves documenting a company’s financial data for internal or external stakeholders. As mentioned earlier, the P&L and cash flow statements are standard financial reports that most companies produce monthly because they provide a broad overview of a company’s financial health. Other common reports include the balance sheet and the income statement, which delve deeper into business activity and highlight financial strengths and weaknesses.
Public companies must file standardized financial reports, such as the quarterly 10-Q and annual 10-K statements, to provide shareholders with detailed information about their investments. Some companies also produce financial reports intended for their internal stakeholders, such as managers and other employees, like sales trend reports. These internal reports help disseminate critical financial metrics and provide team members with insights into their performance.
What Is Included in Financial Reports?
Some financial reports consist solely of columns and rows of numbers, but most provide additional context. In public companies, the CEO (chief executive officer) and the CFO (chief financial officer) must certify the information contained in all financial reports. This certification usually takes the form of notes and explanations, which provide essential context. These additional sections in a financial report are known as “management’s discussion and analysis” (MD&A).
The footnotes section of a report can also contain any information that helps clarify any perceived anomalies in the report. For instance, an unexpected drop in revenue might be accompanied by an explanation of changes in the market that led to the decline. Any disclosure required by law is typically found in the footnotes as well.
Financial reporting is important because it…
Financial reporting is an essential activity for any business. Here are some of the top reasons why:
Provides Transparency and Accountability
Accurate and timely financial reporting allows for a reliable examination of a company’s performance and overall health. Sharing this information fosters an environment of trust and accountability with shareholders, potential investors, creditors, and even the general public. Making this information freely available demonstrates a company’s commitment to openness and strong business practices.
Aids in Decision-Making Processes
Financial reports contain critical data that stakeholders use to make informed decisions. The numbers contained in the reports inform company leadership when they can make capital investments or when they need to cut back on spending and hiring. More detailed, analytics-based reports help leadership assess the company’s liquidity, profitability, and overall financial health, guiding them in the right direction.
Ensures Compliance with Regulations
Regulators rely on a company’s financial reports to ensure law and industry regulations compliance. This is possible thanks in part to standardized reporting practices, which provide a benchmark for auditors and regulators to assess compliance. The reports also help company leadership identify potential non-compliance issues before they result in legal problems, fines and penalties, or reputational damage.
Assists in Attracting Investors
Detailed financial reporting provides potential investors with the information they need to assess a company’s long-term viability. The reports help investors evaluate sales performance, future potential, and any market risks. Following standard reporting practices instills confidence in investors, ensuring they understand where their money is going and how it will be used.
Facilitates Benchmarking
Financial reporting standards provide benchmarks for companies to compare their performance to that of competitors and peers. Critical metrics like profitability, liquidity, and efficiency ratios help leaders set reasonable goals and identify areas for improvement. Benchmarking provides essential context so that, even during downturns, companies can gauge their relative performance in the marketplace.
Financial Reporting Provides the Foundation of Business
It is easy to take financial reports for granted. The basic P&L statement is understood to provide insight into profitability, and the cash flow statement reveals where money is coming from and going. However, delving deeper into the available reports provides valuable information. Most of the critical decisions made by company leadership are informed by examining financial reports. Investors, auditors, and regulators depend on financial reports to perform their roles. In this way, financial reporting can be seen as the foundation of business.
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