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The Importance Of Financial Reporting And Analysis: Your Essential Guide

Financial reporting is an important part of your business at various levels -from a legal point of view, for your investors, and for internal monitoring“Vision without action is merely a dream. Action without vision just passes the time. Vision with action can change the world.” – Joel A. Barker

Financial analysis and reporting are one of the bedrocks of modern business.

While you may already know that financial reporting is important (mainly because it’s a legal requirement in most countries), you may not understand its untapped power and potential.

A report from McKinsey suggests that leveraging data to create more proficient marketing reports and to make more informed decisions can boost marketing productivity by 15 to 20%, which translates to as much as $200 billion based on the average annual global marketing spend of $1 trillion per year. If you apply that same logic to the financial sector or a finance department, it’s clear that financial reporting tools could serve to benefit your business by giving you a more informed snapshot of your activities.

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Utilizing financial data with the help of online data analysis tools allows you to not only share vital information both internally and externally but also leverage metrics or insights to make significant improvements to the very area that allows your business to flow.

To help you unlock the potential of financial analysis and reporting, we’ve produced this guide that answers these burning questions, among others:

  • What is financial reporting and analysis?
  • Do all companies do it the same way?
  • What is the importance of financial reporting?
  • What is the purpose of financial reporting?
  • What are some use cases when it comes to making business decisions?
  • What is the role of this kind of reporting in the real world?

Whether you find the business of doing business particularly interesting, are looking to streamline your organization’s incomings or outgoings, want to understand the purpose of financial reporting, or are simply looking to upgrade your knowledge on financial analysis and reporting, you’ll find all the answers you need right here.

Let’s start by exploring a financial reporting definition.

What Is Financial Reporting?

Financial reporting refers to standard practices to give stakeholders an accurate depiction of a company’s finances, including their revenues, expenses, profits, capital, and cash flow, as formal records that provide in-depth insights into financial information.

Each of these financial KPIs is incredibly important because they demonstrate the overall ‘health’ of a company – at least when it comes to the small matter of money. These types of KPI reports don’t offer much insight in the way a company’s culture or management structure, but they are vital to success, nonetheless.

As we continue, we’ll explore the use cases of financial analysis and reporting, but for now, it’s worth noting that these ‘financial health reports’ are crucial for anyone looking to make informed decisions about their business. Financial reporting software and BI reporting tools offer invaluable information on elements including investments, credit extensions, cash flow in, and so on. Financial reporting and analysis are also legally required for tax purposes.

As Boundless states, “Financial reporting is used by owners, managers, employees, investors, institutions, government, and others to make important decisions about a business.”

Now that we’ve explored what we consider to be the ‘financial reporting meaning’ or financial reporting definition, let’s glance at the benefits of these kinds of reports.

The Benefits Of Financial Reporting

We’ve pondered the question ‘why is financial reporting important?’, looked at real-world use cases, and shared what we consider to be the financial reporting meaning. To round things off, let’s dig deeper into the benefits of this kind of reporting.

  1. Improved debt management: As you will surely know, debt can cripple the progress of any company, regardless of sector. While there may be many different types of financial reporting concerning purpose or software, almost all solutions will help you track your current assets divided by the current liabilities on your balance to help gauge your liquidity and manage your debts accordingly.
  2. Trend identification: Regardless of what area of financial activity you’re looking to track, all types of this kind of reporting will help you identify trends, both past and present, which will empower you to tackle any potential weaknesses while helping you make the kind of improvements that will benefit the overall health of your business.
  3. Real-time tracking:  By gaining access to centralized, real-time insights, you will be able to make accurate, informed decisions swiftly, thereby avoiding any potential roadblocks while maintaining your financial fluidity at all times.
  4. Liabilities: Managing your liabilities is a critical part of your company’s ongoing financial health. Business loans, credit lines, credit cards, and credit extended from vendors are all integral liabilities to manage. By using a financial report template, if you're planning to apply for a business expansion loan, you can explore financial statement data and determine if you need to reduce existing liabilities before making an official application.
  5. Progress and compliance: As the information served up by financial reporting software is both accurate and robust, not only does access to this level of analytical reporting offer an opportunity to improve your financial efficiency over time, but it will also ensure you remain 100% compliant – which is essential if you want your business to remain active.

“It is a capital mistake to theorize before one has data.” – Sherlock Holmes

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3 Different Ways Of Financial Reporting And Analysis

“In a perfect world, investors, board members, and executives would have full confidence in companies’ financial statements… Unfortunately, that’s not what happens in the real world, for several reasons.” – Where Financial Reporting Still Falls Short, The Harvard Business Review article

We won’t get too deep into the ‘financial reporting rabbit hole’ at this point, but we can say with certainty that there are many, many pitfalls associated with this kind of reporting. Some of them are technical pitfalls, while others are ethical (Enron, anyone?).

Right now, it’s enough to understand that there are two main ways that financial reports are standardized, and one critical element to consider when working with EU-based data of any kind:

  • The GAAP (Generally Accepted Accounting Principles). This is the system used by the United States, and almost no one else (just like the Imperial measurement system!).
  • The IFRS (International Financial Reporting Standards). This system is utilized by more than 110 countries around the world, including Canada, Australia, India, and China (although China and India have ‘customized’ the IFRS in their own ways).
  • The GDPR: (The General Data Protection Regulation): The GDPR came into effect on May 25, 2018, designed to modernize the laws that protect the personal information of individuals, which means that if you're handling sensitive financial data of any kind, insights or metrics (involving that of your investors, clients or partners), you must ensure that your reports are compliant.

These fluctuations in standardization have real-world consequences. As the HBR article states:

“Take the British confectionery company Cadbury. Just before it was acquired by the U.S. firm Kraft, in 2009, it reported IFRS-based profits of $690 million. Under GAAP those profits totaled only $594 million — almost 14% lower. Similarly, Cadbury’s GAAP -based return on equity was 9% — a full five percentage points lower than it was under IFRS (14%). Such differences are large enough to change an acquisition decision.”

Why Is Financial Reporting Important?

Let’s get down to brass tacks – what’s the point and the role of financial reporting?

Well, there are three main factors:

  • It is required by law for tax purposes.
  • Financial reporting and analysis give investors, creditors, and other businesses an idea of the financial integrity and creditworthiness of your company.
  • Financial reporting software provides crucial information that you can use to make better business decisions – for example, whether you should open a new branch or not.

To further illustrate the importance of financial statement analysis, let’s dive into each of these three primary reasons a little more thoroughly.

1) Taxes

You may have heard the phrase: the only two certainties in this world are death and taxes (or something similar).

That said, taxes are arguably the biggest reason for the importance of financial statement analysis – basically, you have to use it! The government utilizes such reports to ensure that you’re paying your fair share of taxes. If financial reports weren’t legally required, most companies would probably use management dashboards instead (at least for internal decision-making purposes).

The government’s requirements for these documents has created an entire industry of auditing firms (like the “Big 4” of KPMG, Ernst & Young, Deloitte, and PWC) that exist to independently review companies’ financial reports. This auditing process is also a legal requirement.

2) For other companies, investors, shareholders, etc.

If you’re considering investing money in a company, it only makes sense that you’ll want to know how well that company is doing – according to a standardized litmus test; not measurements that a company has fabricated to make themselves look good.

This is where the importance of financial statements come into play for investors. This also applies to credit vendors and banks who are considering lending money to a company. In these situations, you will need to gain an accurate understanding of how likely you are to be paid back so that you can charge interest accordingly. it’s great to have an investor relations dashboard at hand:

Financial Reporting Example for Investors

**click to enlarge**

The importance of financial analysis and statements also applies to stakeholders. If you own equity in a firm or are an activist investor who owns a major equity position, then having full disclosure of all assets, liabilities, use of cash, revenues, and associated company costs is essential. You will also want to understand if the company is doing something it shouldn’t (such as in the case of Enron).

Due to a series of laws known as Sarbanes-Oxley, there is more standardization/legal cooperation within the world of financial reporting. These laws are designed to prevent another situation like, and we’ll say it again – Enron – from happening.

3) For internal decision-making

As mentioned, financial reports are not the best tools for making all internal business decisions. However, they can serve as the ‘bedrock’ for other reports (such as management reports) that CAN and SHOULD be used to make decisions.

It’s crucial that financial reports are as accurate as possible – otherwise, any management reports (and ensuing decisions) based on them will be sitting on a shaky foundation. This is where companies can run into trouble, using legacy methods (such as one massive spreadsheet that multiple users have access to) rather than reaping the benefits of financial reporting by utilizing financial dashboards instead.

These online dashboards provide at-a-glance information on the financial health of your company, for both yourself and others.

Remember: the government (and outside investors) don’t care WHY your financial reports are inaccurate. They’ll just penalize you for being wrong – it’s that cut and dry.

4) For improved internal vision

Financial analysis and reporting are an accurate, cohesive, and widely accessible means of sharing critical financial information throughout your organization. If your financial insights or data is fragmented, things can quickly fall apart. In a nutshell, this alone answers the question, ‘what is financial reporting and analysis?’

Financial analysis and reporting help to answer a host of vital questions on all aspects of your company’s financial activities, giving both internal and external stakeholders an accurate, comprehensive snapshot of the metrics they need to make decisions and take informed action.

5) For raising capital and performing audits

Our final answer to the question ‘why is financial reporting important?’ is two-fold: for raising funds more accurately and managing your funds more compliantly.

Financial reporting and analysis assists organizations, regardless of industry, in raising capital both domestically and overseas in a well-managed, fluent way – an essential component to ongoing commercial success in today's competitive digital world.

Also, financial analysis and reporting facilitate statutory audits. The statutory auditors are required to audit the financial statements of an organization to express their opinion. Reporting tools or software will give this official concise, accurate, and compliant information – which, of course, is vital.

Your Chance: Want to test a financial reporting software for free? Explore our 14-day trial & take your financial reporting to the next level!

4 Use-Cases For Financial Reporting

Up until now, we’ve looked at things from a big picture point of view. Now, let’s get a little more tangible and a trifle more down-to-earth by exploring some valuable questions that financial reports (and the reports based on them) can help you answer.

1. Is purchasing this stock a good idea?

If you’re really doing your due diligence on a company that you’re considering investing in as an individual or on behalf of your current organization, financial reporting analysis can give you some (relatively) “hard” data that will help you make your decision.

This is also one way you can gain insight into whether a company is potentially under- or overpriced in the stock market.

2. Are we profitable? Will we be in the future?

Without embracing the importance of financial statement, it’s difficult to tell how much money your company is making after paying all of your expenses and payroll. Since one of the main reasons a company exists is to make profits for itself and its shareholders, this is crucial information – no compromises.

3. How much cash ‘runway’ do we currently possess?

If you’ve ever been a part of the management team of a startup, you might have some idea of how stressful it can be not to know if you’re going to be able to ‘make payroll’ in the coming months.

That’s where the importance of ‘financial statement’ comes in.

Cash is oxygen to a business, and financial reporting analysis can help you see how many months’ payroll your business can give out while remaining financially solvent (assuming that revenue numbers stay the same).

This is a good ‘worst case scenario’ exercise to conduct regularly – and it’s even more sturdy if you assume that your revenues will fall over the next few months compared to your best guess projections.

4. Do we have the capital to invest in new lines of business?

Some companies, like Apple, like to sit on colossal amounts of cash. Their strategy is to have this money built up so that they can remain financially solvent even if some pretty catastrophic things happen to the economy.

However, other companies prefer to invest their money if they can do so while remaining financially healthy. For example, computer chipset manufacturers like Intel upgrade their factories and equipment on a regular basis.

These upgrades are extremely expensive, and while they are a good long-term investment, the company in question must make sure they have the short-term cash flow to support these kinds of moves.

3 Common Types Of Financial Reporting

1) Income Statement

This particular report tells you how much money a company made (or lost) in a given time period (typically a fiscal year). It does so by showing you revenues earned and expenses paid, with the ultimate goal of showing a company’s profit numbers.

Visual of a financial reporting example for top-management

**click to enlarge**

2) Balance sheet

This piece of financial reporting software offers a snapshot of your assets and liabilities (aka debts) at a given moment in time. It’s definitely possible to fall into bother with your profitability and cash flow situations while having a healthy balance sheet (especially if you have a lot of money tied up in physical inventory), and this report will help you dig deeper, assisting your strategic decision-making.

A balance sheet is a good overview of the assets and debts of your company at a specific moment**click to enlarge**

3) Cash Flow Statement

This report shows how much money flowed into and out of your business in a period of time. The cash flow statement is crucial for things like making sure you have enough money to make payroll.

Your Cash Flow Statement is very important to know if you have enough money for payroll; it shows you how much money went in and out of your business.

**click to enlarge**

Your Chance: Want to test a financial reporting software for free? Explore our 14-day trial & take your financial reporting to the next level!

To reiterate: why is financial reporting important? Like it or not, financial reporting will be around as long as businesses are making, and indeed, spending money.

Why? For the simple reason that governments will always collect taxes from businesses. As we said, taxes are one of the few certainties in life – and one of the primary reasons for financial reporting.

While you may not be able to choose if you prepare financial reports or not, you can at least choose how you present them. With a financial, real-time dashboard, you can see your company’s financial integrity at a moment’s notice.

To onboard your business on the reporting plane, you can try our financial analytics software, completely free, for a 14-day trial and benefit from all the advantages of datapine’s modern money and investment-handling solutions!