Finance glossary

What is financial reporting?

Bristol James
6 Min

Financial reporting is the process of tracking, documenting and communicating financial activities over a specific time, usually performed on a quarterly or annual basis. For businesses, this process is essential for both executives and investors to maintain confidence in the operational viability of the organisation.

Proper and regular financial reporting is crucial not only for financial success, but it’s a driving factor for business decision-making. Generally, the main person responsible for financial reporting in an organisation will be the Chief Financial Officer (CFO), supported by a team should the organisation be big enough. The CFO would provide detailed analysis and financial reporting to other members of the executive team, board and other key stakeholders as required.

For-profit businesses usually consider the main financial reports to be the balance sheet, cash flow statement, statement of retained earnings and income statement.

The importance of financial reporting

Stronger decision making

Business owners are forced to make decisions every day, whether big or small, that may impact the direction of their organisation. Despite decision making being a key skill for executives and employees alike, a recent executive survey by McKinsey & Company states only 20% of respondents believe their organisations excel at decision-making.

One of the most critical steps in decision-making is assessing the financial risk associated with all the potential outcomes, also known as financial risk management. Key financial statements, such as the balance sheet or income statement, give real-time snapshot of historical performance, profitability, and long-term outlook.

Reassurance for investors and partners

Even for privately held companies, transparency is essential when dealing with investors, a board, key executive stakeholders. To maintain investor interest, it’s expected financial reporting will be detailed and organised. Beyond just being able to report and assess the current state of affairs, financial professionals will need to be able to show long-term outlook, projections, with the added assessment and consideration of external factors which may impact financial performance, such as industry and economic trends.

Lending and raising capital

Financial reporting is crucial when building relationships with creditors. Whether a business is looking to raise capital through loans, private investments or public markets, it’s essential to have detailed and accurate financial reporting to strengthen creditworthiness.

Law and compliance

A more essential element of financial reporting is to meet regulations when it comes to law and compliance. From a legal perspective, financial reporting covers a company’s tax obligations, by making sure documents are submitted to the appropriate government agencies for review (for example, in the U.S. this would be the Internal Recenue Service or IRS).

Future growth

Further to our point on how financial reporting is important for decision making, it allows companies to set their targets for the year based on retrospective performance and data. By reviewing financial reports, companies can strategically allocate spend and budget across departments, make decisions about hiring additional team members, and set details key performance indicators (KPIs) to track success throughout the year.

Requirements for financial reporting

Following Generally Accepted Accounting Principles (GAAP)

GAAP is the set of detailed accounting guidelines and standards in the US that ensure all companies provide clear and consistent financial information (in Australia, the equivalent is the IFRS).

With GAAP, it’s much easier for investors, creditors, and other parties to evaluate how a business or organisation is performing. Under the guidelines, details such as liability declarations and tax preparations are filled in a standardised manner.

In the US, only regulated and publicly traded businesses are obliged to follow these principles. However, since they make the market much more convenient, many private companies will also opt to follow them.

These are the ten concepts behind the GAAP principles:

  1. Principle of regularity. Accountants and businesses are required to consistently adhere to GAAP when managing financial information. A company or its financial team is not allowed to disregard or alter any of these established regulations at any time.
  2. Principle of consistency. The same standards should be applied throughout the financial reporting process. This should prevent potential errors.
  3. Principle of sincerity. An accountant should provide an accurate, unbiased report of the company’s financial state.
  4. Principle of permanence of methods. Like the principle of consistency, the same reporting method procedures should be used throughout the process (this means any report should be easily compared to a different one).
  5. Principle of non-compensation. Both negative and positive values on a financial statement should be reported with full transparency.
  6. Principle of prudence. All reported data should be fact-based and not focused on speculation or forecasting.
  7. Principle of continuity. When making reports and valuing assets, accountants should assume the company will continue to operate.
  8. Principle of periodicity. All financial entries should be reported in the relevant accounting period. This is intended to avoid fudging numbers or anything else that could hide the actual data.
  9. Principle of materiality. Accountants should aim to disclose as much of a company’s financial data as possible.
  10. Principle of utmost good faith. Assumes that all businesses, persons, and parties involved are honest in their reports and transactions.

International Financial Reporting Standards

In the business world, it’s also common to come across the term IFRS (International Financial Reporting Standards). The idea is similar to GAAP in that these are a set of accounting rules that aim to make financial statements more consistent, transparent, and comparable at a global level.

Nowadays, IFRS has replaced many different national accounting standards (it’s used in the European Union and many other places throughout the world). However, some countries, such as the US and China, still choose to operate on different principles.

While there are many different IFRS standards to watch out for, these are the aspects that are most important:

  • Statement of financial position (more commonly referred to as balance sheet): IFRS influences the way different components should be reported on the sheet.
  • Statement of comprehensive income: This can be presented as one statement or divided into a profit and loss statement and a statement of other income.
  • Statement of changes in equity: This should document any changes in a company’s earnings or profits in a specific period.
  • Statement of cash flows: This report focuses on a business’s financial transactions in a specific time period, separating cash flow into operations, financing, and investing.

Although IFRS and GAAP are quite similar, the largest difference between them is the IFRS is principle-based and GAAP is rule-based. For this reason, GAAP leaves less room for interpretation, while IFRS provides more flexibility.

Auditing requirements

The goal behind a financial audit is to objectively examine and evaluate an organisation’s financial reporting to ensure their records are accurate and fair. Audits can either be performed externally or internally by a company’s employees.

Audits follow their own set of standards to ensure accuracy, consistency, and verifiability. In the US, GAAS (Generally Accepted Auditing Standards) are the set of systematic guidelines auditors use to analyse companies’ financial records.

Like GAAP, GAAS also includes ten principles, but they are divided into three separate sections: General standards, standards of field of work, and standards of reporting.

The General Standards are simple:

  1. The auditor is required to have adequate technical training to perform the audit.
  2. The auditor must always be independent and unbiased regarding the audit.
  3. The auditor must always be professional while performing the audit and preparing the report.

Financial reporting software

Did you know that human error accounts for 41% of all accounting mistakes? Today, many accountants and finance professionals have looked at ways to automate tracking and reporting. This helps them save time and money, while also improving accuracy on reports.

Beyond the options to automate reporting, finance departments have become a popular topic in the media as data breaches and cyber security become one of the top cause for financial losses today. In fact, cybercrime costs are predicted to reach $9.5 trillion USD in 2024.

Beyond accurate financial reporting, companies are looking to protect themselves from falling victim to cyber-attacks and phishing attempts, by investing in automated protection technology.

Strong financial reporting is key for success

From everything we’ve discussed, it’s clear that financial reporting not only provides several benefits but also makes the market a more transparent and honest place.

Whether the goal is to optimise workflows, cut debts, or even improve cash flow, this can be achieved when an organisations invest in strong financial reporting.

Summary

  1. Financial reporting is crucial for projecting future profitability and growth, that’s why it is the basis of any successful business operation.
  2. Effective financial reporting can improve decision-making and increase the transparency and credibility of financial statements. Consequently, this can help attract potential investors and build better relationships with stakeholders.
  3. The Generally Accepted Accounting Principles (GAAP) in the US and International Financial Reporting Standards (IFRS) globally provide frameworks for clear, consistent, and comparable financial reporting. The main difference between the two is that GAAP is more rule-based, while IFRS is more principle-based.

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