In business, it’s not always a great idea to follow your gut. When it comes to making financial decisions, hard data can help you remain objective. Financial reporting is an integral part of running and operating a successful business. After all, the more information you have about your operating activities, the better off you’ll be. Let’s take a closer look at the importance of financial reporting.
What is financial reporting?
Financial reporting is the most objective way to assess a company’s financial health. In general, financial reporting provides information about revenue, expenses, profits, cash flow and the health of your balance sheet.
Financial reporting uses financial statements like income statements, balance sheets and cash flow statements to disclose financial information to internal and external stakeholders. Business owners may generate financial reports quarterly or annually.
Financial reports provide information to stakeholders regarding the company’s financial condition. You can use the reports to generate financial ratios, which business owners use to make smarter decisions that can yield positive financial results.
Why financial reporting matters
Financial reports contain vital information about the company’s financial performance. A CFO uses the information to calculate the breakeven point, cash collections and debt financing.
Your breakeven point is the level of sales you need to break even for the month. Your cash collections can tell you if your business is collecting enough cash to operate the business. If your accounts receivable balance is growing rapidly, you’re not pulling in cash receipts fast enough.
Debt financing can tell you if your business generates enough in earnings to repay debts on time. Debt has an impact on your decision-making, and firms that carry a large amount of debt must use earnings to make debt payments.
This information can help you set realistic expectations for the business. And it gives investors a window into your company’s financial health. More importantly, some laws and financial accounting practices require business owners to maintain financial reports. Otherwise, financial reporting is essential for any business for four reasons.
- Paying taxes: the ATO uses various financial reports to ensure you’re paying the right amount in taxes. Accurate financial reporting can decrease your tax burden by making sure you’re not overpaying.
- Attracting investors: investors will want to see your financial reports to understand your company’s financial condition better before they decide to invest. Investors prefer companies that can generate higher profits and cash inflows each year.
- Making decisions: financial reports can help you make tough business decisions. With accessible financial data, you can make those decisions based on hard numbers rather than gut feelings or guesswork.
- Catching costly errors: accurate financial reporting can help you catch accounting mistakes, allowing you to post adjustments and fix mistakes before they impact your business.
Three common financial reports you should be running
Three common financial reports follow standard accounting practices to give you and your stakeholders an accurate picture of your company’s finances.
1. Balance sheet
A balance sheet shows the company’s assets, liabilities and equity as of a specific date. The balance sheet formula subtracts your company’s assets from its liabilities to determine the equity. The balance sheet formula follows:
Assets – liabilities = equity
Assets are resources your company uses to generate revenue and profits. Liabilities are the amounts your company owes to other parties. Equity—also known as owner’s equity, shareholder equity or stockholder’s equity—is the difference between the assets and liabilities.
Let’s say you sell all of your assets for cash and use it to repay all of your liabilities. Any remaining cash is equity. The equity is the true balance of the business, and the balance includes retained earnings that are kept to fund operations.
2. Income statement
An income statement —also known as a profit and loss statement—shows the company’s revenue and expenses for an accounting period. The income statement formula subtracts revenue from expenses to determine net income. The income statement formula follows:
Revenue – expenses = net income
3. Cash flow statement
The cash flow statement, or statement of cash flows, shows the company’s cash inflows and outflows for a period of time. Cash flows are separated into operating, investing and financing activities. The cash flow statement formula adds a beginning cash balance with net changes in each activity to determine the ending cash balance. The cash flow statement formula follows:
Beginning balance in cash + net changes in operating, investing and financing activities = ending cash balance
These three reports are the most important financial statements for financial reporting. In general, financial statements show a company’s financial performance and profitability for a period of time.
How to use financial reports to track the health of your business
Financial reports allow you to make business decisions using real financial data. This allows you to be completely objective when assessing the financial health of your company.
But you can’t get the full picture without tracking that data against key performance indicators (KPIs). KPIs allow you to keep tabs on your business’s financial performance. Here are three actionable KPIs you can use to measure your financial health:
1. Gross profit margin
Your gross profit margin shows you how much of your revenue is profit after you factor in expenses like the cost of production. The gross profit margin formula first subtracts revenue from the cost of goods sold. Then it divides that number by revenue. The gross profit margin formula follows:
(Revenue – costs of goods sold) ÷ revenue = gross profit margin
Keep an eye on your gross profit margin. If your gross profit margin percentage begins to drop, you need to look for ways to lower your expenses. The cost of goods sold includes materials and labour costs that you can’t trace directly to production.
2. Net profit
Your net profit is the amount of money you have after you’ve paid all your bills and expenses. Net profit is your bottom line. The net profit formula subtracts total revenue from total expenses. The net profit formula follows:
Total revenue – total expenses = net profit
In general, you’ll want to have net profit rather than net loss. Net profit means your business is making money. If your net profit begins to drop, you’ll want to investigate.
3. Current ratio
Use the current ratio KPI to determine if you have enough money to fund a large purchase, like a new piece of machinery. The current ratio formula divides current assets by current liabilities. The current ratio formula follows:
Current assets ÷ current liabilities = current ratio
A current ratio of less than 100% is cause for concern. It means you may not have enough cash coming in to pay your bills. Tracking this KPI can alert you to incoming cash flow problems.
In all cases, financial reports provide you with the critical information you need to track KPIs. The more often you generate and review your financial reports, the more accurate your KPIs will be.
What is a financial analysis report and how do you generate one?
A financial analysis report helps you clearly communicate your company’s strengths and weaknesses to potential investors. It contains a detailed analysis of your company’s financial health. A financial analysis report can help convince investors to invest in your business.
Follow these eight steps to generate a financial analysis report:
- Start with a company overview and an executive summary. Investors need to understand who you are and what your company does.
- Dive into your investment thesis. Summarise the positives and negatives of your company as an investment.
- Don’t forget to cite your sources. Following your thesis, list the resources you used to generate your findings and how you collected your data.
- Note any significant financial events that may have impacted your company’s finances.
- In the crux of the financial analysis, include your company’s valuation. A valuation is an independently determined value for the company.
- List any risk factorsthat could negatively impact your company’s valuation.
- Next, include detailed results. Your financial reports will come in handy here.
- At the end of the financial analysis, recap what you’ve presented. Highlight why you believe your company is a smart investment.
- A well-written financial analysis takes time. Financial reports can make the process much faster and easier. But don’t be afraid to ask for help. A financial analyst can help you paint an accurate picture of your company’s financial situation.
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