A financial report is one of the foundations of modern business. Aside from being legally required, the financial statements are crucial tools in making business decisions.
Financial reporting is a way of adhering to standard practices to show the world an accurate picture of a company’s finances which include their:
All of these financial metrics are essential because they show the financial well being of a company. You can’t expect financial reports to reveal much about a company’s management or culture.
If you want to make informed decisions about a business, then an analysis of its financial reports are needed before diving in.
Samples of these significant decisions include investing in a business or extending credit. You can also check whether the business has good cash flow in the short term. Financial reporting is legally required in almost all countries for tax purposes.
Financial reports are useful to owners, employees, managers, investors, gov’t, institutions and others so that decisions about a business can be made.
Some common samples of financial reports are:
A report that shows you how much money a company has earned or lost in a given period (usually in a fiscal year). It shows revenues earned and expenses paid for the purpose of coming up with a company’s profit numbers.
You can see a table of the operating expenses, gross profit margin, operating profit margin, opex ratio, net profit margin, gross profit, net profit, revenue, sales expense, marketing expense, admin expense, other income, other expenses, and earnings before interest and taxes.
This report provides a snapshot of your company’s assets and liabilities at a given moment. It’s possible to have issues with your profitability and cash flow while having a healthy balance sheet.
This happens when you have much money tied up in physical inventory.
Usual information include: return on assets, working capital ratio, return on equity, debt-equity ratio, balance sheet, total assets, current assets, cash, accounts receivable, inventory, long-term assets, total liabilities, current liabilities, accounts payable, other liabilities, shareholder equity, common stock, and current earnings.
Cash Flow Statement
This report shows how much money flowed in and out of your business in a certain period. The cash flow statement is important for things like having enough money for payroll.
Information on this report usually includes: working capital, cash conversion, quick ratio, current ratio, cash balance, sales outstanding, payable outstanding, cash on month end, and accounts payable.
There are different ways of financial reporting which is why certain pitfalls are experienced. There are technical and ethical pitfalls(remember Enron?).
There are two ways that financial reports are standardized:
- The GAAP(Generally Accepted Accounting Principles). America uses this system and no one else.
- The IFRS(International Financial Reporting Standards). This standard is used by more than 110 countries worldwide, including Canada, India, Australia, and China.
These differences have real-world consequences.
A good example is British company, Cadbury. Just before the U.S. firm Kraft bought it, it reported IFRS based profits of $690 million. Under the GAAP those profits only amounted to $594 million.
Cadbury also had a GAAP based return on equity of 9% while IFRS reported it at 14%.
Financial reporting is important for three reasons:
- It is mandatory by law for tax purposes.
- It gives investors, creditors and other businesses a glimpse of the integrity and creditworthiness of your company.
- It provides important information for making business decisions like whether you should open a new location or not.
The gov’t uses these reports to ensure that you are paying the right taxes. If financial reports were not legal requirements, most companies would be using management dashboards instead.
This has resulted in an industry of auditing firms like the top 4 of KPMG, PWC, Ernst & Young and Deloitte. Auditing is also a legal requirement.
There are a series of laws known as Sarbanes-Oxley which has resulted in more legal cooperation within the world of financial reporting. The laws were made to prevent another Enron-like situation from happening.
Financial reports should be made as accurate as possible. Any management report that is based on inaccurate data would be founded on a shaky foundation. Your company can run into trouble when you opt for legacy methods of doing financial reports.
Financial reporting is here to stay, it will be around as long as companies are making and spending money. Taxes are not going to disappear anytime soon.
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