Why is Financial Reporting Important? (2024)

Financial reporting is the accounting process for communicating financial information. Allcompanies do some form of external or internal financial reporting — or both. Externalfinancial reports must conform to accounting and reporting standards, and internal reportsshould do so, too, though the two types of reports can look different because they servedifferent purposes:

• External reporting is used by company outsiders, like regulatory agencies, taxauthorities, investors, lenders and trade partners, so it has more rigid requirements.
• Internal reporting is used by a company's senior management team to informdecision-making, so it can be more tailored to their specific informational needs andthe company's business objectives.

Whether external or internal, the challenge for most companies is creating accurate, timelyfinancial reporting in an efficient way. Here's what's involved and how to make itbetter.

What Is Financial Reporting?

Financial reporting — the communication of financial information to external andinternal stakeholders — is most often achieved by the "core"financial statements: balance sheet, income statement and statement of cash flows.But it can also come in many other forms, depending on the information needs of the reader.

For example, public companies file quarterly 10-Q and annual 10-K statements with theSecurities and Exchange Commission (SEC) containing extensive notes to the financialstatements, supplementary schedules and the management's discussion and analysis(MD&A). For internal stakeholders, financial reporting can comprise any financialreportsthat management wishes to generate, such as detailed sales reports, trends and keyperformance indicators (KPIs).

Key Takeaways

• Financial reporting is an accounting process that communicates financial data toexternal and internal stakeholders, such as shareholders, lenders and senior companymanagement.
• External financial reporting requirements are different for public and privatecompanies, but the reports are universally required by law for tax reporting.
• The financial statements, SEC forms, annual report and MD&A are some items includedinfinancial reporting packages.
• Integrated financial reporting software helps make financial reporting more accurate andtimelier through automated processes, which have the added benefit of allowing resourcesto be redeployed to analysis and action.

Financial Reporting Explained

Companies of all sizes engage in some form of financial reporting, whether for compliancewith outside regulatory agencies or industry custom, or for internal managementdecision-making. Large public companies must comply with stringent financial reportingobligations issued by the SEC; private firms might have financial reporting obligations tolenders or owners; and even small firms must do some degree of financial reporting when theyprepare their tax filings.

Financial reporting is a continual process, with periodic deliverables throughout the fiscalyear. Annual financial reporting happens at the end of a company's fiscal year, whileinterim financial reporting covers periods less than one year, typically months or quarters.

Why Is Financial Reporting Important?

Financial reporting — and its components — tells a story about a company'sfinancial health. An important underpinning is that the information in financial reportingpackages must conform to U.S. Generally Accepted AccountingPrinciples (GAAP) or International Financial Reporting Standards (IFRS); thisconformity provides reliability and consistency. More specifically, financial reporting isvital for the following four purposes:

1. Raising capital.

   A company's financial story is especially important when the company is looking toraise capital, whether through public markets, private investments or loans.Outside parties use financial reports to assess creditworthiness and the strength ofthe company's operations.

2. Reassurance.

   While most financial reporting is retrospective, investors, partners and evencustomers/suppliers can also use it to form predictive opinions regarding futureperformance and viability. For example, suppliers might use a company's financialreporting to determine whether to start doing business together, based on thetrajectory of the company's sales.

3. Financial analysis.

   Financial reporting is also indispensable to internal management, serving as afoundation for analyzing operations, measuring KPIsor even calculating compensation for employees. For example, analyzing a dashboardof accounts receivable KPIs, such as day's sales outstanding, can help seniormanagement gauge the effectiveness of the billing and collection staff, as well aspredict cash flow.

4. Compliance and law.

   Financial reporting is also important because it satisfies compliance requirementsand laws. Most companies have at least one stakeholder whose continuing involvementrequires periodic financial reporting. For public companies, that could be the SEC.Private companies might have a loan that requires periodic reporting of certain debtcovenants. Beyond that, financial reporting is legally required by the InternalRevenue Service (IRS) — every US business's "universalstakeholder."

What Is the Purpose of Financial Reporting?

Financial reporting provides insight and transparency into a company's financialposition and its operations. It's meant to give stakeholders in the company the rightinformation, in the right amount of detail, to make better-informed decisions. This is true,whether for an external investor, a taxing agency or internal management. Good financialreporting gets different parties on the same page with a single version of the truth, andgives credibility to the company and its management. On the other hand, fraudulent orinaccurate financial reporting can torpedo a company's reputation and value.

What Is Included in Financial Reporting?

A lot of effort goes into financial reporting, derived from several different areas in acompany. Financial controllers and their accounting staff are responsible for the financialreporting process in most midsize companies. In larger, public companies, the CFO and CEOare required to certify the reported information, as are external auditors, while theinvestor relations department handles distribution of financial reports to the public viapress releases, websites, earnings calls and other external communication channels. Insmaller companies, the lead staff accountant, or even the business owner, controls most ofthe financial reporting function, sometimes with the help of external accountants.Fortunately, requirements for small businesses are usually proportionately scaled down.

Regardless of company size, items typically included in external financial reporting are:

• Financial statements
• Notes to the financial statements
• MD&A
• Annual report
• SEC filings, including the 10-K and 10-Q, along with many potential others, like aprospectus, proxy statement or 8-K (for unusual events), among others.

A key point for financial reporting is timeliness. Even the most accurate and completefinancial report has less value if it is out of date.

Key Types of Financial Statements and Reporting

Financial statements — standardized summaries of a company's financial profile— are the primary component of financial reporting. Each financial statement has itsown focus, so it is most useful for conveying a company's story when grouped togetherwith other statements typically included in a reporting package, such as the quarterly 10-Qsand annual 10-Ks of US public companies. The detailed accounting data underlying financialstatements can be sliced and diced for internal reporting in dashboards when supported byautomated accounting systems and analysis tools. Key types of financial statements anddashboards used for financial reporting are:

1. Income statement:

   The incomestatement reports revenue, expenses and net income/(loss) for a fiscalperiod. It's often considered the most important of the three basic financialstatements because it focuses on operating results. It's commonly presented incomparison to prior fiscal periods.

2. Balance sheet:

   A balance sheetshows a company's financial position as of a certain point in time. It lists acompany's assets, liabilities and equity in accordance with the accountingequation: Assets = Liabilities + Equity. The balance sheet is used to gauge acompany's net worth, its overall financial strength and its ability to fundfuture growth.

3. Cash flow statement:

   The cash flowstatement presents a summary of how a company received and disbursed cashand cash equivalents over a stated period. It classifies sources and uses of cashinto operating activity, investing activity and financing activity; strips awaynoncash activity (e.g., depreciation) from net income; and reveals the amount andsource of a company's liquidity. By analyzing the cash flow statement,stakeholders can draw their own conclusions about a company's ability to meetit* cash needs.

4. Financial dashboard:

   Used for internal reporting, a financial dashboard is an automated, graphicalrepresentation of a company's underlying accounting and operational data.Different dashboards can be configured to show any KPI or analysis that isappropriate for a particular manager. Real-time dashboards provide the most usefulinternal financial reporting.

5. CFO dashboard:

   This is an important example of a role-based financial dashboard and is one thatsummarizes the key data required by the most senior financial officer. Typicalreporting on a CFO dashboardmight be working capital KPIs, accounts receivable and accounts payable turnover,credit utilization, payroll data and budget trending, as well as summary financialstatements.

Benefits of Financial Reporting

A financial reporting package serves many purposes beyond satisfying compliance and legalrequirements. Key benefits of financial reporting include:

1. Identifying trends:

   Internal analysis of a company's financial reports can help the company spottrends in the business so that it can exploit emerging opportunities and mitigaterisk from potential challenges.

2. Managing cash flow:

   Financial reporting helps a company stay on top of its cash balances and monitor cashinflows and disbursem*nts, all of which is vital to businesses of all sizesand industries.

3. Enhancing working capital management:

   Real-time financial reporting helps senior management calculate and balance adequatecurrent assets in order to meet current liabilities without creating anunderutilized surplus. In a similar fashion, it helps manage debt, especially debtrelated to revolving credit lines and other short-term credit facilities, likecredit cards.

4. Kickstarting budgets and forecasts:

   Financial reporting, especially the income statement, provides a solid foundationwhen creating future-looking analyses, as might be required for budgets, forecastsand pro-forma scenarios.

5. Optimizing operations:

   You can't manage what you don't measure. Internal financial reporting is atool for helping a business become more effective and efficient, through KPIs andother regular reports.

6. Improving business partner relationships:

   A company enhances its relationships with its business partners, suppliers,customers, creditors and investors by being a good company to do business with.Financial reporting can help managers make more timely payments to suppliers, setcompetitive prices for customers, establish creditworthiness with creditors andconduct meaningful communication with investors.

Financial Reporting Requirements

Financial reporting requirements are constantly changing. The various standard setters, likethe Financial Accounting Standards Board (FASB), International Accounting Standards Board(IASB) and Government Accounting Standards Board (GASB), are always tweaking the accountingstandards to make financial reporting more accurate and useful. The SEC and the IRS updatetheir rules in line with those tweaks, as well as in response to changes in the nationaleconomic climate and in government laws and programs.

Small, privately owned companies have fewer external financial reporting requirements thanpublic companies. While the former are not required to release financial statements or otherfinancial data to the public, they are required to file tax estimates and annual tax returnswith the IRS. Additionally, lenders usually require various regular financial reports, suchas specific debt covenant calculations. For those small companies interested in raisingcapital through smaller registered offerings, there is a dedicated SEC Office of SmallBusiness Policy that provides guidance on financial reporting requirements.

Larger privately held companies sometimes voluntarily release financial reports to the publicas a form of marketing. By giving the public some generalized information, they buildinterest among potential partners and acquisition targets, trading partners and the media.Their financial reporting usually is similar to that of large public companies, aiming bothto satisfy their nonpublic stakeholders and to meet internal management purposes.

Public companies have the most stringent financial reporting requirements, which areprimarily dictated by the SEC. The SEC financial reporting manual is hundreds of pages long,not including its guidance publications, called Staff Accounting Bulletins, which help CFOsand controllers interpret the rules. Most common SEC financial reporting requirements arethe quarterly 10-Q, the annual 10-K, the 8-K for reporting significant events and Schedule13D, which is filed when any person or entity attains 5% ownership of a single class ofstock.

10 Use Cases for Financial Reporting

When a company tells its story through financial reporting, different stakeholders arelistening for different reasons. Broad reasons are to track and analyze a company'scurrent health — hence, the ever-present primary financial reporting use case ofcomplyingwith regulatory, legal and tax requirements. But there are many other specific external andinternal use cases for financial reports. Here's a list of 10 more:

External

1. By potential investors who are considering buying stock in a company.

2. For family, friends and private investors who are contemplating making an equityinvestment in a company.

3. For banks' analyses of credit applications for loans, lines of credit andletters of credit for overseas activity.

4. By credit card issuers evaluating a corporate or business credit card application.

5. For potential merger or acquisition activity.

6. For bargaining with labor unions.

Internal

7. For senior management, to analyze profitability at all levels: consolidated, bysubsidiary, by location and by product.

8. To identify, analyze and manage cash flow for mature companies or assess burn ratefor startup companies.

9. To build budgets, projections and forecasts.

10. To support decisions regarding business expansion or reduction.

Financial Reporting Examples

Private companies disclose limited financial information on their corporate website, usuallyin the form of press releases. However, there are thousands of publicly available examplesof financial reports from public companies. Their reports are posted on their websites andin press releases, and are included in the SEC's publicly accessible EDGAR online database.

Here are the main examples:

Form 10-Q (quarterly earnings release):

At the end of each quarter, public companies file a form 10-Q with the SEC, a key financialreport used by investors and the public markets. The 10-Q includes unaudited financialstatements and summary commentary from company management, as well as supplementarydisclosures and schedules for the just-ended quarter and for the fiscal year to date. Inmany ways, it is like a “mini” annual 10-K. These are important financialreports becausethey provide the public with three periodic updates throughout the year on how a company isdoing, rather than having to wait 12 months for an annual 10-K.

They can have a significant impact on a public company's stock price, since they maysignal significant trends, for good or bad. For example, a recent 10-Q from a major pete-tailer attributed its 27% increase in net sales (compared to the same quarter in the prioryear) to an increase in new customers, combined with a rise in how much continuing customerswere buying. However, the e-tailer also discussed how supply chain challenges related to theCOVID-19 pandemic might hamper future increases. The company's stock price dropped 9%the day after the 10-Q filing.

Notes to the financial statements:

The notes and supplemental schedules found in 10-K filings can be as informative as thefinancial statements themselves. For example, one interactive entertainment retailercommonly located in malls across the US discussed in the notes to its most recent 10-K theimpact that recent changes in lease accounting standards (ASC 842) had on its financialresults and its ability to renegotiate many of its 300+ leases.

Form 10-K, Part 1 — aka "The Business":

Another interesting part of 10-K financial reporting can be found in Part 1, which is aqualitative discussion of a company's business, including strengths, weaknesses andother important matters that provide context for the quantitative data in the company'sfinancial story. For example, an interesting discussion of the impact that the COVID-19pandemic had on one large fitness chain's operations can be found in Part 1 of its mostrecent 10-K.

Annual reports:

Annual reports are considered more "friendly" than 10-Ks because they containcharts, illustrations, photos and a letter from the CEO. Historically printed on glossypaper, annual reports are geared toward shareholders and contain much of the same basicfinancial data as financial statements. Additionally, they are often used as marketingmaterial for employees, customers and the company's community of business partners.There are several searchable, commercial online repositories to help find annual reports,but they can also be found directly on most companies' websites. Digital annual reportsare designed to reflect a company's brand and be interactive, combining financial datawith playful illustrations, video and audio. For example, an athletic sports brand usedchart generators and animation in its online annual report, earning it awards.

Management's discussion and analysis (MD&A):

The MD&A gives company management a platform to tell its story in an easy to understand,yetdata-heavy, narrative. It's found in annual reports and 10-Ks, and discusses acompany's performance over the past three fiscal years, with an emphasis on the mostrecent year's sales and income compared to past years. The MD&A is also an opportunityto discuss unusual events, trends and outlook. For example, a large technology providerdiscussed the operational results of its various cloud, licensing, hardware and serviceslines of business, and the reasons it anticipates future growth, in a recent MD&A.

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Conclusion

Financial reporting is the way businesses communicate financial data to external and internalstakeholders. External stakeholders — like regulatory agencies, current and potentialshareholders and investors, and lenders — use financial reports to draw conclusionsabout a company's current and future financial health. Internal financial reporting isless rigid and used by internal management to inform decision-making. Rules and guidelinesfrom GAAP, IASB, SEC and others provide a standard framework for financial reporting.Accounting departments can provide the most accurate and timely financial reporting by usingintegrated financial reporting software.

Financial Reporting FAQs

What are the four basic financial reports?

There are three basic financial statements: the income statement, balance sheet and statementof cash flows. When a fourth is referenced, it's usually the statement of retainedearnings.

How is financial reporting done?

Financial reporting is typically the last step in the accounting close, although automatedsoftware can provide real-time access to the data. It is done in compliance with GAAP, IFRSand SEC rules. Internal financial reporting is done by using financial dashboards, scheduledreports and ad hoc reports.