Financial Reporting

What is Financial Reporting?

Financial reporting is the process of communicating a company’s financial data, usually quarterly or annually. Companies use financial reports to communicate their current financial status to stakeholders, including investors, lenders, regulators, and the general public.

Depending on the type of financial report a company is preparing, they may use it to show:

• Financial performance
• Current cash position
• Cash flow
• Changes in equity
• Significant events or transactions
• Accounts receivables and payables
• Inventory levels
• Debt levels

The balance sheet, income statement, and statement of cash flows are the most common financial reports. Others include the statement of shareholders’ equity, the statement of retained earnings, and management’s discussion and analysis (MD&A).

Synonyms

• Financial statements
• Financial disclosure
• Annual report
• Quarterly report

Importance of Financial Reporting

Besides being a legal requirement for publicly traded companies, financial reporting is an essential part of an organized, well-run business. Accurate financial reports help leaders and stakeholders make informed decisions about a company’s financial health, potential risks, and future prospects.

Decision-Making for Businesses

Financial reports help businesses monitor key financial metrics like profitability, solvency, and liquidity. These form the basis of financial analysis, which supports high-level decision-making.

Through detailed financial analysis, companies can pinpoint specific areas that require improvement. Income statements, for example, reveal trends in revenue and expenses, highlighting profitability issues or cost centers the business needs to address.

By understanding the company’s current financial position and performance, management can use financial reports to project future conditions and make decisions that align with company’s financial capacity and goals. This might involve deciding on capital investments, setting next year’s budget, developing new products, or entering new markets.

Transparency for Stakeholders

It isn’t just those within the business who have to make strategic decisions. Anyone who invests in that company, lends it money, or regulates it also needs to understand its financial health.

• Investors need to perform a risk assessment and understand an investment’s potential return.
• Creditors always assess a company’s current and future ability to repay loans before lending money.
• Regulators monitor financial reports to ensure businesses are complying with accounting standards and reporting accurate information.

Beyond those stakeholders, employees may also have an interest in a company’s financial report to understand the company’s health and stability, potentially impacting job security. And suppliers sometimes look at them to determine a new customer’s creditworthiness and payment terms.

Taxes

Financial statements provide the necessary details about a company’s revenue, expenses, and profits, which are the basis for tax calculations. The IRS and state tax authorities require accurate financial information for correct tax assessment. This is particularly important because taxes are calculated on profits, and financial reporting helps in determining these profits accurately.

Beyond the P&L, proper financial reporting allows businesses to track their expenses accurately, which is crucial for claiming all permissible deductions and tax credits. This helps in minimizing the tax burden legally. Detailed record-keeping, as part of financial reporting, ensures that businesses can substantiate these claims in their tax filings.

Reports also serve as supporting documents during audits and tax filings. They offer a detailed account of a company’s financial transactions over the fiscal year, which must be reported to tax authorities. Inaccuracies or omissions in these reports can lead to legal penalties and additional taxes due to underreported income.

Legal Compliance for Public Companies

For publicly traded companies, financial reporting is not only a regulatory requirement but also a legal one. Investors put their money into stock, which is a security that represents ownership in the business. So, they need to know how the company is doing financially.

Public companies have to adhere to Generally Accepted Accounting Principles (GAAP) in the US, or International Financial Reporting Standards (IFRS) globally, which dictate how to report various financial elements in their the financial statements. These standards ensure the financial statements are clear and comparable across different fiscal periods and entities.

Types of Financial Reports

Core Financial Statements

As mentioned previously, the three core financial statements are the balance sheet, income statement, and statement of cash flows.

Let’s dive into each one.

Balance Sheet

The balance sheet provides an overview of a company’s financial position at a specific point in time. It lists the organization’s assets, liabilities, and shareholder equity. In other words, it shows:

• What a company owns (assets)
• What it owes (liabilities)
• What’s left over for shareholders after all debts are settled (equity)

Businesses report on current assets, or those they expect to be converted into cash or used within one year (e.g., cash and cash equivalents, accounts receivable, inventory, and short-term investments). They also report on non-curent assets (which will not be used or converted into cash within a year), such as property, plant, and equipment (PP&E), intangible assets, and patents.

They also report on current liabilities (those due within a year, like accounts payable and short-term debt) as well as long-term liabilities that are not due within a year, such as long-term debt and pensions.

Shareholder equity includes common and preferred stock, retained earnings, and other equity instruments. This is the remaining value after deducting liabilities from assets.

Income Statement

The income statement summarizes a company’s revenues and expenses over a specific period, typically a fiscal quarter or year. It’s also called the profit and loss statement, or P&L, because the goal is to show the net profit or loss incurred over this period.

Key components of an income statement (in this exact order) are:

• Revenues
• Cost of goods sold (COGS)
• Gross profit
• Operating expenses (OpEx for short)
• Depreciation and amortization
• Operating income (also known as earnings before interest and taxes, or EBIT)
• Interest expense
• Taxes
• Net income

These components provide a clear view of a company’s operational efficiency, cost management, and overall profitability during the reporting period. For instance, a significant increase in revenues compared to the last reporting period indicates growth and market demand for the company’s products. A decrease in OpEx might show improved operational efficiency.

Statement of Cash Flows

The cash flow statement shows the inflow and outflow of cash over a specific reporting period. It is based on three categories of financial activities:

• Operating activities — Cash generated or used in business operations (e.g., cash from sales and payments to suppliers)
• Investing activities — Cash spent or received through investments in PP&E, other businesses, stocks, etc.
• Financing activities — Cash flows from raising capital through equity, loans, and dividend payments.

The statement of cash flows is essential because it helps investors understand how a company generates and uses its cash. It also reveals any potential liquidity issues the company might be facing.

Additional Financial Reports

There are several other financial reports that companies can use to provide a more comprehensive view of their financial standing, depending on their needs or industry.

Statement of Retained Earnings

The statement of retained earnings — also called the statement of owners’ equity — displays the changes in the amount of retained earnings during a specific period.

Here are its typical components:

• Opening retained earnings — The amount of retained earnings at the beginning of the period, often the start of a fiscal year.
• Net income (or loss) — Transferred from the income statement, it represents the profit or loss the company generated during the period. Net income increases retained earnings, while a net loss decreases them.
• Dividends — Distributions of profits paid out to shareholders to shareholders during the period, reducing the amount of retained earnings.
• Adjustments — Corrections of errors or changes in accounting policy, which can either increase or decrease the figure.
• Closing retained earnings — The final amount of retained earnings at the end of the period. It’s equal to the sum of opening retained earnings, net income (or loss), and adjustments, minus dividends.

The statement provides insight into how much of the company’s profits are being reinvested in the business versus being distributed to shareholders, which is crucial for understanding the company’s reinvestment strategy and financial health.

Statement of Shareholder Equity

The statement of shareholder equity, sometimes called the statement of stockholders’ equity, provides a summary of the changes in shareholders’ equity over time.

It includes information on:

• Common and preferred shares
• Additional paid-in capital (APIC)
• Retained earnings
• Treasury stock
• Accumulated other comprehensive income (AOCI)

This statement is particularly useful for companies that issue different classes of stock, as it provides a breakdown of how each class is affected by changes in equity.

Management Discussion and Analysis (MD&A)

The MD&A is a narrative report included in the annual report that provides an overview and analysis of a company’s financial performance during the year. In this section, executives provide insights into significant trends, risks, and factors that created the business’s current situation and those which may impact the company’s future results.

This financial report isn’t required. But it provides valuable information for investors and shareholders when making strategic decisions about their investments.

Notes to Financial Statements

Notes to financial statements are additional disclosures that provide details on specific items in the financial statements.

They can include:

• Explanations of accounting policies
• Significant events
• Material non-cash transactions not explicitly reported in the primary financial statements
• Information about contingent liabilities or commitments

The purpose of these notes is to provide additional context and clarify any potential confusion or discrepancies in the numbers reported in the primary financial statements. They’re commonplace where a financial report is used during fundraising, acquisitions, lawsuits, or changes in accounting standards.

Aging Reports

An accounts receivable aging report is a financial report that shows the unpaid invoices and their due dates. It helps companies keep track of who owes them money, how long an invoice has been outstanding, and which customers have delinquent payments.

An accounts payable aging report is similar but tracks a company’s unpaid bills to suppliers or vendors.

These reports are useful for managing cash flow. They also help companies identify and fix potential collection issues or late payment problems with customers or suppliers.

Industry-Specific Reports

Depending on the industry, a business might report on certain financial ratios and metrics that provide more insights into its financial health.

For example:

• Banking and financial services businesses measure their capital adequacy ratio (capital set aside to mitigate potential risks) and net interest margin (interest income generated by banks vs. the interest paid out to their lenders, relative to the amount of their interest-earning assets).
• Retailers report on YoY same-store sales growth and sales per square foot.
• Hotels calculate their average daily rate (average rental revenue earned per rented room) and occupancy rate.
• SaaS companies report on average revenue per user (ARPU), customer lifetime value (CLV), customer acquisition cost (CAC) and related metrics like CAC payback and the LTV:CAC ratio.

Annual Financial Reporting Timeline

Choosing a Fiscal Year

The fiscal year differs from the Jan-Dec calendar year (though companies can choose to report on a calendar year if they like). A business may choose to end its fiscal year on different dates, depending on its unique business cycle, tax strategy, and ease of financial reporting.

• Business cycle alignment. Retail businesses often have a fiscal year ending on January 31 to capture the holiday season sales. Apple ends its fiscal year in late September (last Sunday of September), likely to finalize its annual financial reporting just after revealing new products and capturing initial sales figures from these launches.
• Industry practices. Some businesses may align their fiscal years with industry norms or regulatory environments. Companies that work closely with government contracts often synchronize their fiscal years with the federal government’s fiscal year, which runs from October 1 to September 30, to streamline financial operations.
• Tax and accounting benefits. Businesses might select a fiscal year that allows for better distribution of workload and potentially lower costs for financial services such as auditing and tax preparation. Off-peak fiscal years might lead to lower rates from these service providers during their less busy periods.

Monthly, Quarterly, and Annual Reports

The reports you generate monthly, quarterly, and annually all serve different purposes.

• Your monthly report primarily serves to provide management with immediate feedback on the results of day-to-day operational decisions, monitor cash flow, and adjust short-term strategies.
• The quarterly report provides a broader overview of your business’s financial health over three months. They’re used both internally and externally, and US public companies are required to file them with the SEC in the form of 10-Q filings.
• The annual report is a comprehensive summary of your business’s yearly performance. It’s used primarily to communicate with shareholders and investors, review progress against long-term strategic goals, and plan for the future.

The main distinction between these three reports lies in their level of detail and use case.

Monthly reports give managers insights into activities like marketing campaigns and product launches. Quarterly reports balance detail with timeliness to assess the broader impact of shorter-term strategies. Annual reports, on the other hand, are more high-level and comprehensive, looking at the overall annual performance of the business.

Internal Processes

Every month, accounting teams close the books, reconcile revenue and payments, review financial statements and KPIs (key performance indicators), and prepare reports for management meetings.

Quarterly reporting involves more in-depth analysis and comparison of actual results against budgeted or forecasted figures. This process requires finance team members to review of past quarters to identify trends, evaluate the effectiveness of strategies, and make adjustments for the next quarter.

Annual reporting begins with the preparation of year-end financial statements, followed by an audit or review by external auditors. Companies then use this information to produce their annual report, which includes a comprehensive overview of the business’s financial performance, goals achieved, and plans for the future years.

Filing with Regulatory Bodies

Public US companies are required to file an annual Form 10-K report with the SEC within a particular timeframe from the end of the fiscal year. This somewhere within 60 to 90 days, depending on company size.

The Form 10-K includes several key components:

• Business overview
• Risk factors
• Selected financial data
• Management’s discussion and analysis (MD&A)
• Three financial statements and supplementary data
• Internal control over financial reporting

The financial statements included in the 10-K must be audited by an independent auditor. And once it’s filed, it is available on the SEC’s EDGAR database for public viewing.

Apart from the annual 10-K, public companies are also required to file quarterly reports (Form 10-Q) and are subject to continuous disclosure requirements through the SEC’s Regulation FD to ensure that all investors have equal access to material company information.

Some private companies also have to report to regulatory bodies, depending on the industry and location.

Public Release

It’s common for companies to publish their annual reports on their website. This is an opportunity to communicate with anyone who may have an interest in your business — e.g., shareholders, investors, potential customers, or future employees.

For some, publishing annual financial reporting through a press release is a strategic move to draw in investors. Others may wait until regulatory filing requirements are met before making the report public.

Financial Reporting Regulations

GAAP vs. IFRS

GAAP is the set of rules, standards, and procedures that public companies in the US must follow when compiling financial statements. IFRS is the international equivalent of GAAP, and it’s used in over 120 countries.

While the two sets of standards are similar, there are differences in how they’re applied. GAAP is rules-based, offering specific guidance on how to account for certain transactions. IFRS is principles-based, providing broad principles and allowing companies to exercise judgment in applying them.

A prime example of this is revenue recognition. Rules are slightly different between ASC 606 and IFRS 15, with the former using more specific guidelines.

Another example is the treatment of fixed assets. Under GAAP, fixed assets are reported at historical cost and depreciated. With IFRS, revaluation to fair market value is permitted.

GAAP also allows companies to use last-in-first-out (LIFO), first-in-first-out (FIFO), and weighted average cost when valuing inventory and COGS. IFRS prohibits LIFO, only allowing FIFO and weighted average cost.

Public vs. Private Companies

The biggest difference between public and private comapnies and how they’re regulated lies in the level of disclosure required. Private companies almost always have less stringent financial reporting requirements. They’re generally allowed to keep their financial information confidential.

On the other hand, regulatory bodies like the Securities and Exchange Commission (SEC) have strict disclosure requirements for public companies. They must report quarterly and yearly financial statements, disclose significant events, and comply with any additional reporting regulations that apply.

Importance of Compliance

When it’s all said and done, companies lose an average of $14.82 million to non-compliance. That factors in:

• Fines and penalties
• Business disruptions
• Decreased productivity
• Lost revenue
• Legal fees
• Reputational damage

By prioritizing compliance at your organization, you avoid all of the above. You’re also ensuring accuracy and transparency in your financial documents, which improves your relationships with stakeholders and potential future investors.

Essential Technology for Financial Reporting

Accounting Software

Accounting software is a must-have for any business, big or small. It streamlines your accounting processes and saves you time and money in the long run. In addition to streamlining data collection, it automates tasks like bank reconciliation, invoicing, and tracking expenses. It also produces financial reports that are accurate and easy to understand.

Financial Reporting Software

Financial reporting software goes beyond accounting software by providing in-depth analysis and customizable reports. It integrates with your accounting system to gather data and generate real-time dashboards, graphs, and charts for better data visualization. And it automates much of the clerical work that comes with preparing financial reports, saving your team valuable time.

Cloud-Based Solutions

From a financial reporting standpoint, billing automation is one of the most important tools in your tech stack. Cloud-based billing software consolidates your financial data, streamlines reporting processes, and provides real-time insights into your business’s financial health.

And companies can revolutionize revenue recognition by implementing an automated, AI-powered billing platform that auto-reports in the period it’s earned (i.e., when the product/service is delivered). This is especially important for SaaS companies, which charge an upfront subscription fee to be recognized at the end of the month (or periodically over a 12-month period).

Other cloud-based software that streamlines the reporting process includes project management software, ERP, time tracking tools, budgeting software, and financial modeling platforms. Use these to understand your costs, current and future demand, and track the flow of money. 

Key Takeaways on Financial Reporting

Every year (or quarter), there’s a 100% chance your business will have to produce financial reports. To sum it all up, let’s review some of the key takeaways:

• The three primary financial statements are the income statement, balance sheet, and cash flow statement.
• GAAP (US, rules-based) and IFRS (international, principles-based) are two sets of standards used for financial reporting with some key differences in their applications.
• Public companies have strict disclosure requirements from regulatory bodies like the SEC, while private companies generally have less stringent regulations.
• Prioritizing compliance improves accuracy and transparency in financial reporting, saving businesses from potential fines, penalties, and reputational damage.
• Essential technology for financial reporting includes accounting, reporting, and cloud-based software like automated billing.
• Compliance costs well into the millions, so prioritizing accuracy and transparency in your financials ends up creating tremendous cost savings.

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