What is Financial Reporting? Types, Objectives, Benefits, and Limitations

Financial reporting is the comprehensive account of all the business transactions, including expenses and income details. It shows the financial position of a firm over a specific period. It can be made quarterly or annually.

It is created to give any business the oversight of its financial dealings and helps in forecasting future requirements. It is the reporting of all the accounting-related information for its users or group of users.

This report is usually released to the public in the form of financial statements for understanding the financial condition of an organisation to take further business decisions with that firm. The third parties could be shareholders, customers, creditors, government authorities, etc., who are interested in this report. Making this report is the main function of the controller.

A financial report is prepared in two forms, one for internal use and the other for external people like stakeholders, potential investors, etc.

Any industry, either a manufacturing or a service industry, has multiple departments. These departments may or may not be independent, but they are somehow connected through the link called finance. The accounts department is directly related to them. So, the financial reporting of individual departments is made and sent to various stakeholders.

This reporting can be of two different types-

1. Financial reporting made for stakeholders- It contains the list of expenses and income generated from various resources for giving a clear picture to the stakeholders. Based on that, they can make further business decisions.

2. Management reporting for internal use- It is made for internal management purposes, for example, profit and loss calculations.

Objectives of financial reporting

There are several objectives of making the financial report of a firm. Few can be listed as follows:

• It provides information on the credit and investment decisions made by the firm.
• It provides the required information for assessing the cash flow (securities, income earning, profit and loss decisions for lenders)
• It gives essential information about economic resources that include shareholder claims, claims made by creditors, and provides clarity to other financial claims, etc.
• It provides information about the financial results, profit and loss information or expenses made during certain periods, etc.
• It gives clear information on the liquidity and solvency of the firm. It provides information on how the firm gets the funds required for running the business and how it utilises the funds received. It also explains the lenders about the ways of investing money in the business.
• Every business enterprise needs to get the results of its performance to go forward and plan the business. It needs to understand its financial position after a certain period. Usually, after one year, a business stabilises and requires forecasting. Here, the financial report plays a big role. It not only shows a clear picture of the financial position but also directs towards future decision-making. It shows the accounts of the last date is the financial year-end, and with the help of the balance sheet, it shows the balances for future business investments.

Types of Financial Reporting

1. Balance sheet

A balance sheet is in tabular form and contains the balance of assets, liabilities, and equity. The balance sheet represents the basic equation of accounting. Since the balance can change every day, this sheet keeps on updating frequently. Therefore, this sheet is presented at the end of a particular date. When you submit the financial report, this sheet will be updated till the last day of the financial year.

2. Income statement

Income statements are nothing but the statement of the incomes and expenses during a period. The income statement is different from the balance sheet as it is prepared for a certain period, which could be a week, a month, or a year. Income from various sources can be calculated by deducting the costs involved.

3. Statement of cash flows

A statement of cash flow consists of the statements of cash inflow and cash outflow generated through various activities in an organisation within a certain period.

Cash flow statement is made considering activities under three categories as follows:

• Operating activities- the cash flow generated by the manufacturing and other operational activities fall under this.
• Investing activities- the cash flow generated through equities, interest generated from the investments made, shares and debentures, etc., is considered under these activities.
• Financing activities- the cash flow generated through investors and various financial institutions who invest in the business comes under these activities.

4. Statement of equity of shareholder

Statement of shareholder’s equity considers the statement showing the capital investment made by stockholders and the earnings retained by the company through that. Similar to the balance sheet, this statement is also presented on a particular date. Hence, it is time-bound.

Benefits of Financial Reporting

There are several benefits of creating a financial report for a firm. We can list them as follows:

• It improves the debt management of a firm.
• It helps in managing the liabilities through loan management and credit management.
• It helps in real-time tracking of the accounts, which aids in liquidity management. The information of available funds for business helps the firm in making expansion plans.
• It helps in identifying the trends of past and future. A comparative study can be done for creating business forecasting.
• It is a helpful tool in the planning of the business. To make sound business decisions, companies need accurate information on the availability of capital.
• It enhances the quality of business decisions taken by public and internal management.
• It helps in maintaining transparency with customers.
• It helps in maintaining the share prices of the firm and treating all the investors equally.
• Employees understand the company’s growth potential, and hence job security is increased. It, in turn, decreases the employee turnover rate.

Limitations of Financial Reporting

Like any other thing, financial reporting also has certain limitations.

1. Financial reports are not futuristic

Financial statements give the data from last year, and hence it is historical. The analysis only clears the picture of the past, and the results cannot be applied directly to forecast anything in the future. However, the stakeholders and creditors are more interested in the future position of the firm so that they can make business decisions based on that. It is a limitation to the utility of these reports.

2. Financial statements are tools and not solutions

Financial reports show the profitability of the firm and the financial strength as well. But it does not say anything about how you will improve the numbers and develop the business. So, it proves to be a good measuring tool but no solution to the negative results.

3. It ignores the changes in the price level

In certain cases, the prices of commodities change frequently. However, the financial reports are made, considering the current rates. Hence, if the price changes are not accounted for, the results could be misleading. In some cases, the efficiency may increase by considering the new prices, but the actual efficiency may remain less due to uncertainty.

4. It does not consider the qualitative aspects

The financial reports show the only numbers. It lacks the consideration of human resources in the accounting process. It neglects the efficiency, technical know-how, and profitability of its employees. Hence it does not measure the qualitative aspect involved in the business.

5. In the absence of reliable data, it can give misleading results

They are calculated based on the data provided by the firm. If the data is not reliable enough, the results could mislead. Hence, it’s not completely reliable.

6. Intangible assets are not considered

Financial reports consider the expense made to avail the intangible assets like creating a brand image. On the other hand, it does not consider intangible assets as assets. So, this creates a drastic change in the actual reports as compared to the prepared ones.

Takeaway

Financial reports are an important part of the business. They have several benefits for the firm. If properly considered, they can prove to be an essential tool in business improvement.

Also read:

1) Top Financial Tips for Millennials or Young Adults
2) Best Tips for Customer Retention for a Small Business
3) Should You Hire a Financial Advisor if You Run a Business?
4) What Is the Best Advice for a Young, First-Time Start-Up CEO?
5) OkCredit: Simple, Paperless & Secure solution for businesses

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FAQs

Q. What is financial reporting?

Ans. These are the statements created to show all accounting information of the firm over a certain period.

Q. What are the types of financial reporting?

Ans. Financial statements are created in 4 types- balance sheet, income statement, cash flow statement, and shareholder’s equity statement.

Q. What is the main purpose of a financial report?

Ans. A financial report shows the financial position and helps the stakeholders make investment decisions related to that business.

Q. How do you calculate financial reports?

Ans. The financial report is made in the form of 4 statements- balance sheet, income statement, cash flow statement, and shareholder’s equity statement. These financial statements are made for different departments and combined to give the overall financial report of that firm.