The Purpose of Financial Reporting
1 of 11 in Series: The Essentials of Keeping Your Business Accounts
Financial reports are the documents and records you put together to track and review how much money your business is making (or not). The purpose of financial reporting is to deliver this information to the lenders and shareowners (the stakeholders) of your business. If someone else is supporting part of your business, financial reporting must be part of the essential contract between you and them. Your lenders and investors have the right to know if their money is being spent wisely and returning a profit.
What a financial report should accomplish
A financial report should answer certain basic financial questions:
Is the business making a profit or suffering a loss, and how much?
How do assets stack up against liabilities?
Where did the business get its capital, and is it making good use of the money?
What's the cash flow from the profit or loss for the period?
Did the business reinvest all its profit?
Does the business have enough capital for future growth?
Businesses often assume that the readers of the financial statements and other information in their financial reports are fairly knowledgeable about business and finance, in general, and understand basic accounting terminology and measurement methods, in particular. Don’t expect to find friendly hand holding and helpful explanations in financial reports you read, and realize that drafting a financial report yourself takes a lot of accounting know-how.
Keeping your financial report legal
Financial reporting is governed by statutory and common law, and it should be done according to ethical standards. Unfortunately, financial reporting sometimes falls short of both legal and ethical standards. These standards and requirements for accounting and financial reporting often change, so you need to stay updated. The reasons for these changes include the following:
Scandals: Without a doubt, the rash of accounting and financial reporting scandals over the last two decades was one major reason for the step-up in activity by the standards setters.
The Enron accounting fraud not only brought down a major international CPA firm (Arthur Andersen) but also led to passage of the Sarbanes-Oxley Act of 2002. Sarbanes-Oxley includes demanding requirements on public companies regarding establishing and reporting on internal controls to prevent financial reporting fraud.
Complexity: Doing business has an ever-increasing level of complexity. When you look at how business is being conducted these days, you find more and more complexity — for example, the use of financial derivative contracts and instruments.
The legal exposure of businesses has expanded, especially in respect to environmental laws and regulations. There's also a move toward the internationalization of accounting and financial reporting standards.
The price of dealing with these situations has been a rather steep increase in the range and rapidity of changes in accounting and financial reporting standards and requirements. You must make sure that your financial reports follow all current rules and regulations.