Objectives of Financial Reporting
Financial reporting serves a number of purposes and has several objectives:
- Provide Information to Users: The main objective of financial reporting is to provide high-quality financial information about a company to external users, such as investors, lenders, and creditors. This information can be used to make informed decisions about providing resources to a company, such as buying its shares or lending money to it.
- Assess Financial Performance and Position: Financial reporting allows users to assess a company’s financial performance (i.e., its profitability over a given period) and its financial position (i.e., its assets, liabilities, and equity at a specific point in time).
- Monitor Management Stewardship : Financial reporting enables shareholders and others to monitor the management of the company. The information provided in financial reports can help assess how well management has performed their duty to make efficient and profitable use of the company’s resources.
- Assist in Regulatory Oversight: Regulatory agencies use financial reports to ensure companies are following laws and regulations, such as paying the correct amount of tax or adhering to financial reporting standards.
- Facilitate Economic Decision Making: High-quality financial reporting facilitates efficient functioning of capital markets and the overall economy. It allows investors to compare the financial health of different companies, leading to more informed investment decisions and better allocation of resources.
To achieve these objectives, financial reporting must be clear, complete, reliable, relevant, and comparable. The financial statements that form part of the financial report – the balance sheet, income statement, statement of changes in equity, cash flow statement, and notes – each contribute to achieving these objectives.
Example of the Objectives of Financial Reporting
Let’s take a fictional tech startup, FutureTech Inc., as an example to illustrate the objectives of financial reporting:
- Provide Information to Users: FutureTech Inc. releases its annual report which includes financial statements. An investor is interested in investing in FutureTech, and they use the information in these financial statements to understand the company’s revenues, costs, assets, liabilities, cash flow, and other key financial metrics.
- Assess Financial Performance and Position: The investor sees that FutureTech’s revenue has grown significantly over the last year, and the company has a healthy amount of assets compared to its liabilities. This helps the investor assess FutureTech’s financial performance and current financial position.
- Monitor Management Stewardship : The financial report also includes information about FutureTech’s management decisions, such as investing in research and development or acquiring another company. Shareholders use this information to assess whether management is making good decisions to increase shareholder value.
- Assist in Regulatory Oversight: Regulatory bodies review FutureTech’s financial reports to ensure the company is complying with financial reporting standards and paying the correct amount of taxes. They also check that FutureTech is providing a fair and accurate view of its financial situation.
- Facilitate Economic Decision Making: Based on the financial reports and their own analysis, the investor decides to invest in FutureTech, demonstrating how financial reporting can aid economic decision making. At the same time, other potential investors might decide not to invest based on the same information, showing how financial reporting can help allocate economic resources efficiently.
In all these ways, the objectives of financial reporting are being fulfilled. FutureTech’s financial report is providing valuable information to various users, helping them make informed decisions, and contributing to the efficient functioning of the economy.