Financial reporting is an accounting process that is primarily used to communicate financial information. Most companies perform some sort of external or internal financial reporting and sometimes both. It is one of the essential processes for both investors and businesses, as it provides important information regarding the financial performance of a business over a period of time. Financial reporting is also monitored by the government and financial authorities to make sure fair trade compensation and financial activities. In this article we will discuss what is financial reporting along with its components in detail. We will also discuss why is it so important for businesses.
Understand Financial Reporting?
Financial reporting is a process through which internal and external stakeholders get the financial information of a business over a specific time period mostly on a yearly or quarterly basis. It is mainly achieved with the help of financial statements such as statement of cash flows (inflow and outflow), balance sheet and income statement. It is essential for businesses as it is used to estimate the future profitability, public review, and position and growth of the business.
Assume it as a financial checkup for businesses. A financial report is like a bank statement for investors, creditors, and regulators. Just as a bank statement reflects where your money stands, it reflects the performance of the company and whether it is safe to invest or lend money.
The Core Components of Financial Reporting
Financial reports can further be divided into three categories
- The Balance Sheet: It reflects the details about a company’s assets, net worth, and liabilities as of a specific date.
- The Cash Flow Statement: It reflects the flow of cash in the company over a specific period of time.
- The Profit & Loss (P&L) Statement: It reflects the profit and loss generated by a business over a specific period of time.
Now discuss all these components in detail:
Balance Sheet
A balance sheet reflects the assets and liabilities of a company for a specific date. It is also refere as the statement of financial position. A balance sheet is usually created by the end of a fiscal year. A balance sheet contains three main component assets, equity, and liabilities.
- Assets- Assets are the resources owned by a business, such as money, buildings, and machines.
- Liabilities- liabilities are the legal obligations that require the outflow of resources, such as cash, services, and goods.
- Equity- Equity can be measured by subtracting the liabilities from the value of assets owned by a company.
Basic presentation of the balance sheet
| Assets | Amount | Liabilities and equity | amount |
| Cash | 2,00,000 | Loan | 2,00,000 |
| Machinery | 4,00,000 | Business Equity | 6,00,000 |
| sum | 6,00,000 | Total | 8,00,000 |
The basic formula for a balance sheet-
Assets = Liabilities + Equity
A balance sheet report is very beneficial for owners, lenders, and investors, as it provides some useful insights. Owners get the information about the strength of their business. Lenders use it determine the ability of a business to service its loan. Investors use it to understand whether they should invest in the business or not.
Cash Flow Statement
A cash flow statement provides information about the movement of money within the business. This flow of money mainly comes from three activities: revenue, value per share, and expense. These cash flows are of two types.
- Cash Inflow- Cash inflow in accounting describes the money that enters your business.
- Cash Outflow- Cash outflow refers to the amount of money that goes out of your business.
Example of a cash flow statement
| Activities | cash |
| Investment | +2,00,000 |
| Finance | -4,00,000 |
| Operation | +4,00,000 |
| Total | +2,00,000 |
A cash flow statement draws a clear image of the flow of cash. If the business has a negative cash flow, it cannot be sustained over a long period of time. This is the main reason why it is considered as the most critical section of the financial report.
Profit & Loss (P&L) Statement
The Profit and Loss statement is also known as the income statement. It tells us how much profit or loss a business generates over a specific time period. In this statement, we document the income that the business received and the costs that were incurred during the specific month, Quarter, or year.
Basic example of P&L statement:
| Details | Income |
| Revenue | 5,00,000 |
| Cost of Goods(COG) Sold | 2,00,000 |
| Gross Profit | 3,00,000 |
| Operating Expense | 1,50,000 |
| Net Profit | 1,50,000 |
This is a report that every business should be aware of, as it reflects how much money a business generates and how much it spends. The end of this statement represents the net income or net loss generated by the business.
Various Financial Reporting Processes
Financial reporting is very important for businesses as it provides an accurate, transparent, and timely report about the financial health of a business that helps in better decison making, and building trust among the investors. There are two types of financial reporting processes.
- Internal Reporting- it isused by company insiders like internal management.
- External Reporting- it is used by outsiders such as investors, lenders, and regulators.
Let’s discuss them in detail:
Internal Reporting
It is a type of financial reporting process that provides detailed customized finance related data for a company’s higher authority to make strategic decisions. It can be prepared on daily basis, monthly basis, weekly basis, or as needed. It is mainly used by executives, managers, and the internal team.
External Reporting
External financial reporting process is used to prepare and disclose company’s financial health to outside stakeholders. It is usually prepared annually, monthly or quarterly basis. It is mainly used by investors, lenders, and stakeholders. It must comply with standard accounting rules like GAAP or IFRS.
Key Standards: GAAP vs IFRS
There are some sets of predefined standards for financial reporting in various countries. These are two primary accounting frameworks that are widely accepted in most of the countries for financial reporting.
- GAAP: It stands for Generally Accepted Accounting Principles.
- IFRS: It stands for International Financial Reporting Standards.
Generally Accepted Accounting Principles(GAAP)
It is a set of rules followed by the companies in united states to prepare their annual inventory reported in the financial statement. It is more investor friendly compared to IFRS. It allows investors to compare the financial statements of various companies and make the best decision regarding their investment.
International Financial Reporting Standards(IFRS)
Various countries like India, Australia, EU, Russia, South Korea, etc. follow IFRS framework. It is a set of rules/ standards developed by IASB (International Accounting Standards Board). This framework is being used by various countries to prepare financial reports across the globe.
Comparison between IFRS and GAAP
Let’s compare both of these frameworks to get a better understanding of them.
| Area | GAAP | IFRS |
| Approach | Rules-based | Principles-based |
| Inventory | LIFO allowed | LIFO not allowed |
| Inventory write-downs | Cannot be reversed | Can be reversed |
| Development costs | Expensed | Capitalized if criteria met |
| Fixed asset revaluation | Not allowed | Allowed |
| Impairment testing | Two-step (more complex) | One-step (simpler) |
| Extraordinary items | Rarely Allowed | Not allowed |
| Revenue recognition | Detailed guidance | Broader principles |
| Financial statements order | Balance Sheet first | Income Statement first |
Benefits of Accurate Financial Reporting
Financial reporting provides numerous benefits to businesses.
- Raising capital- financial reports play a major role in raising capital as various investors use financial reports to analyze the financial condition of the business. If the financial report is accurate it makes the decision making more easier for investors and lenders.
- Improved Transparency- Financial reports improve the transparency among the customers, investors, and lenders. It also builds trust among various stakeholders of the business.
- Better Forecasting- financial reports also improved the forecasting for the future. By analyzing the past data businesses can set the future targets. For example businesses use past profit and loss data to predict future growth.
- Law compliance- financial reports are also used by businesses to comply with the local law. Various financial authorities also use financial reports to check whether businesses follow the local laws or not.
Conclusion
In recent times business uses more artificial intelligence to create and analyze financial reports. Usage of artificial intelligence saves time and also reduces the risk of manual error. This article will help you to get the basic idea about what is financial reporting, why is it so important, and what are its various components which makes it so useful for businesses. For more account related content please check our other articles.