Financial Reporting
Financial reporting involves the disclosure of financial information to the various stakeholders about the financial performance and financial position of an organization over a specific period of time. These stakeholders include shareholders, creditors, public, debt holders, potential investors, and regulatory authorities.
Financial reporting’s primary objective is to provide high-quality financial reporting information concerning economic entities, primarily financial in nature, useful for economic decision-making. It is used to track, analyze and monitor an entity’s money, making it a very useful management tool for driving growth and building sustainable business practices.
Financial reports are often audited by government agencies, accountants, firms, etc. to ensure accuracy and for tax, financing, or investing purposes. Misrepresentations, errors, and fraud in financial reporting can result in significant penalties and reputational harm for the entity involved.
Key components of financial reporting include:
- Balance Sheet: Also known as the statement of financial position, it reports an organization’s assets, liabilities, and shareholders’ equity at a specific point in time.
- Income Statement: Also known as the statement of profit and loss, it shows how much revenue a company earned over a specific time period (usually a year or a quarter), along with the costs and expenses associated with earning that revenue.
- Cash Flow Statement: This statement shows the company’s cash inflows and outflows during the reported period. It provides information about a company’s operating, investing, and financing activities.
- Statement of Changes in Equity: Also known as a statement of retained earnings, it shows all changes to the balance of shareholders’ equity over the reporting period.
- Notes and Disclosures: These are additional notes that provide more detail about certain items in the financial statements.
The exact requirements of financial reporting standards can vary from one jurisdiction to another, but many follow the International Financial Reporting Standards (IFRS) or the standards set by the Financial Accounting Standards Board (FASB) in the United States.
Example of Financial Reporting
Let’s consider a simplified example of a company’s financial reporting. Let’s say we have a small company named “Example Inc.” and here are its financial statements for the year 2023:
- Balance Sheet as of December 31, 2023:
- Assets: $1,200,000 (including cash, accounts receivable, inventory, and property, plant, and equipment)
- Liabilities: $400,000 (including accounts payable, accrued expenses, and loans)
- Shareholders‘ Equity: $800,000 (assets minus liabilities)
- Income Statement for 2023:
- Revenues: $1,000,000
- Cost of Goods Sold: $600,000
- Operating Expenses: $200,000
- Net Income: $200,000 (revenues minus cost of goods sold and operating expenses)
- Cash Flow Statement for 2023:
- Cash from Operating Activities: $210,000
- Cash used in Investing Activities: -$50,000 (for example, purchases of property, plant, and equipment)
- Cash from Financing Activities: -$60,000 (for example, repayment of a portion of loans)
- Net Increase in Cash: $100,000
- Statement of Changes in Equity for 2023:
- Opening Equity: $600,000
- Net Income: $200,000
- Dividends Paid: -$50,000
- Closing Equity: $750,000 (opening equity plus net income minus dividends)
- Notes and Disclosures:
- Example Inc. discloses that it uses the first-in, first-out (FIFO) method to value inventory.
- Example Inc. discloses that it has a loan with a bank that carries a 5% annual interest rate and matures in 2025.
These statements would be used to present the company’s financial performance and position to shareholders, potential investors, creditors, and other stakeholders. They provide a wealth of information for financial analysis, such as calculating financial ratios and identifying trends in revenues and expenses.
