Financial reporting is the way by which a company shows its financial performance to stakeholders. The company prepares and presents financial reports periodically, usually quarterly and annually.
Stakeholders interested in the company’s financial statements to make economic decisions. They include investors, lenders, shareholders, and governments.
What is the purpose of financial reporting?
Financial reporting provides essential financial information in making economic decisions. Through its output, investors, creditors, and other interested parties can make decisions about the provision of company resources. That includes decisions about buying and selling equity and debt securities as well as providing loans.
Say you are a stock analyst. Financial information is an essential part of you in developing a stock valuation model. With it, you can judge what the fair price of a company’s stock should be. You might be unable to build a model relying only on operational information.
Likewise, if you lend money to the company, through financial statements, you could assess a company’s creditworthiness. You can calculate the company’s leverage level, coverage ratio, and various other financial ratios.
Standardization
Standardization of financial reporting is essential. As you know, transactions within companies are very complex and diverse. Accountants make assumptions and detonations to present them in the financial statements. Of course, if unstandardized, such assumptions and estimations will vary among accountants.
And for this case, standardization in reporting provides consistency. It makes financial statements more comparable. With standards, you will be more confident in making performance comparisons between two or more companies.
Two global financial reporting standards are:
- International Financial Reporting Standards (IFRS) by the International Accounting Standards Board (IASB)
- Generally Accepted Accounting Principles (GAAP) by the Financial Accounting Standards Board (FASB).
In a standard financial statement, you’ll find the following sections:
- Balance sheet or statement of financial position. It presents the company’s assets, liabilities, and shareholder’s equity at a certain point in time. The accounting equation describes the relationship between the three, i.e.; assets are equal to liabilities plus shareholder’s equity. Assets represent the company’s resources. Liabilities represent creditor claims against these resources. And, equity represents shareholder claims against resources after obligations to creditors are fulfilled.
- Income statement provides information related to financial performance during the accounting period. In this section, you can find the company’s revenues and expenses. And, revenue minus expenses is equal to net profit.
- Statement of change in equity. This section reports every investment change by a business owner. It helps you to understand the changes in the company’s financial position.
- Cash flow statement. This section presents cash outflows and inflows. It consists of three groups: operating cash flow, investing cash flow, and financing cash flow. Through this section, you can find out how much money the company makes in an accounting period.
Too for public companies, financial statements are more complex. In addition to the four sections, the regulator asks companies to present:
- Management’s report on internal control over financial reports.
- Independent auditor’s report
- Notes to financial statements
