What Does Financial Reporting Aim to Achieve?
Financial reporting involves collecting a company’s financial information to create and share a report that reflects its overall financial status. For businesses, producing regular financial reports is crucial, thus, understanding the significance of financial statements is essential.
Financial statements play a key role in ensuring transparency and accountability in the market. By law, companies must record all transactions and use this data to generate financial statements, which are then compiled into a report and made publicly accessible online.
These reports offer a snapshot of the company’s financial health, showcasing its performance in daily operations. The purpose of financial reporting is to provide this snapshot to both internal and external entities, including a country’s revenue agency, investors, stakeholders, and creditors.
A comprehensive financial report should address several important questions:
- Is the business profitable or incurring losses?
- What are the company’s assets, and how do they compare to its liabilities?
- What is the business’s working capital, and is there a positive or negative cash flow?
- Has the business reinvested its profits?
- Does the company have the potential for growth, and does it possess the capital for expansion?
Three Main Goals of Financial Reporting
- Inform Investors: Financial reporting provides information to investors about how business funds are reinvested and the efficient utilization of capital. This helps investors assess whether investing in your business is a sound decision.
- Monitor Cash Flow: Keep track of where your business’s money comes from and where it goes. Understanding whether the business is making a profit or incurring losses indicates its overall performance and ability to cover debts while sustaining growth.
- Analyze Financial Position: Regularly assess assets, liabilities, and owner’s equity to anticipate future outcomes and gauge the business’s potential for growth.
Financial reports adhere to International Financial Reporting Standards (IFRS), a set of global standards encompassing taxation, accounting, and legal requirements. This ensures that a business’s financial information is comprehensible worldwide, a crucial aspect given the rise of global companies and international stakeholders. Note that the United States follows Generally Accepted Accounting Principles (GAAP) as an exception to IFRS.
Types of Financial Reports
Summarizes a business’s financial status at a specific moment, outlining the value of its assets, liabilities, and owner’s equity.
Profit and Loss Statement
Reveals a business’s expenditures and earnings during a set period, indicating whether it made a profit or incurred a loss.
Cash Flow Statement
Illustrates the sources and uses of a business’s money, also known as a statement of cash flows or CFS.
Statement of Changes in Equity
Also known as a statement of owner’s equity or retained earnings, it displays how much money a business retains rather than distributes to shareholders. Typically, these retained earnings are used for debt payments or reinvested in the business.
Together, these statements offer a comprehensive view of a business’s financial well-being.
Why are Financial Statements Important?
A company’s financial statements provide a snapshot of its financial performance during a specific period. These statements, including the income statement, balance sheet, cash flow statement, and statement of retained earnings, are generated from the company’s accounting records.
To ensure consistency, businesses follow the IFRS when recording transactions. IFRS is a set of guidelines established by an independent organization that governs the uniform tracking and recording of all financial activities.
These statements serve as a tool for assessing a business’s performance and ensuring compliance with legal requirements. Overall, financial statements play a crucial role in maintaining accurate records of a company’s financial health.
Financial reporting serves as a means for businesses to share financial information with both internal and external parties. External stakeholders, such as regulatory agencies, shareholders, investors, and lenders, rely on these reports to assess a company’s present and future financial well-being. Internally, management uses financial reports to support decision-making. Standard frameworks from entities like GAAP, IASB, SEC, and others guide financial reporting.