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.
Financial reporting is the most objective way to assess a company’s financial health. In general, financial reporting provides information about revenue, expenses, profits and losses, 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 a comprehensive annual financial report or a report on a quarterly basis.
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.
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 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 and creditors 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.
Three common financial reports follow standard accounting practices to give you and your stakeholders an accurate picture of your company’s financial position.
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 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 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.
An income statement—also known as a profit and loss statement—shows the company’s revenues 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
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, a financial statement analysis shows a company’s financial performance and profitability for a period of time.
These financial reports can indicate if your company is prosperous or if you’re heading towards trouble. Financial reports are a fundamental source of financial information, so they must follow basic accounting standards. These accounting standards and principles, as well as international financial reporting standards, ensure accuracy and consistency among reports.
Laws require public companies to prepare financial statements at the end of every quarter and financial year. These are known as quarterly and annual reports. Public companies generate additional reports, including the calculation of comprehensive income.
producing and reviewing monthly or weekly financial reports can give you a more accurate understanding of your company’s financial health. This understanding can help you mitigate financial mistakes.
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:
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 dip, 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.
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.
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.
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:
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, as well as financial reporting software such as QuickBooks Online, can help you paint an accurate picture of your company’s financial situation.
