What Exactly is Financial Reporting? Definition, Types, and Importance

Financial reporting is an important process for businesses and investors because it provides key information about financial performance over time. Financial reporting is also monitored by government and private regulatory institutions to ensure fair trade, compensation, and financial activities.

Typically, you record financial activities on several key statements, which others can use for review. In this article, we discuss what financial reporting is, why it's important, what financial statements are common and who uses and monitors these documents.

What is financial reporting?

Financial reporting is the process of documenting and communicating financial activities and performance over specific time periods, typically on a quarterly or yearly basis. Companies use financial reports to organize accounting data and report on current financial status. Financial reports are also essential in the projections of future profitability, industry position and growth and many financial reports are available for public review. There are several primary statements to use when reporting financial data, and the information you include in these documents fulfills several key objectives of financial reporting:

• Tracking cash flow

• Evaluating assets and liabilities
• Analyzing shareholder equity
• Measuring profitability

Importance of financial reporting

Financial reporting is a critical practice that's important because it:

Monitors income and expenses

Tracking income and expenses is another important process that financial reporting supports. Monitoring financial documentation is necessary for effective debt management and budget allocation and provides insight into key areas of spending. Monitoring income and expenses ensures companies track debts regularly to remain transparent in competitive markets. Therefore, financial reporting gives you documentation methods to track current liabilities and assets. Accurate financial documentation is also necessary to measure important metrics, including debt-to-asset ratios, which investors use to evaluate how effectively companies pay down debt and generate revenue.

Ensures compliance

Financial reporting encompasses specific processes that companies follow to comply with mandatory accounting regulations. Each document you use to evaluate financial activities comes under the review of several financial regulatory institutions. This makes accurate documentation crucial to ensure all financial reports comply with tax regulations and financial reporting criteria. Accurate financial reporting also simplifies tax, valuation and auditing processes, reducing the time to complete necessary financial obligations and further validating financial compliance.

Communicates essential data

Key shareholders, executives, investors and professionals all rely on current financial data to make decisions, plan budgets and monitor performance. The importance of open communication and transparency is necessary to support funding, investment opportunities and financial review. Many investors and creditors rely on the information companies communicate in financial documentation to assess profitability, risk and future returns.

Supports financial analysis and decision-making

Financial reporting is crucial for performing analysis to support business decisions. Using financial statements improves accountability and supports the analysis of critical financial data. Documents like the income statement and balance sheet provide real-time information that you can use to track historical performance, identify key areas of spending and create forecasts more accurately. With better-developed data models and detailed financial analysis, reporting helps businesses evaluate current activities and make decisions for future growth.

Types of financial reports

Most companies document financial data on three key statements but sometimes include the shareholder equity on a separate report. The following documents make up the primary records of a company's financial activities:

Balance sheet

A balance sheet records the total assets, liabilities and equity you currently possess. A quick review of the balance sheet can show you the total assets, minus the equity and liabilities. Typically, businesses track balance sheets on a quarterly basis and may include data from balance sheets when creating yearly reports. Balance sheets also provide a real-time assessment of your current asset liquidity and debt coverage. Commonly, balance sheets outline the following line items:

• Liquid assets, including cash, certificates of deposit, short-term securities and treasury bills
• Current assets, including accounts receivable, inventory, fixed assets and prepaid expenses
• Current liabilities, including short-term and long-term debt, accounts payable, payable wages and dividends, tax expenses and prepayments from clients
• Shareholder and owner equity values, like retained income, receivable dividends, capital gains and stocks

Income statement

While a balance sheet reviews current activities, the income sheet tracks these processes over a longer period. Some businesses track income statements quarterly and use these documents to monitor financial processes throughout the year. The income statement shows performance for revenue, net income, expenses and earnings per capital share if companies open shares on the stock exchange. The income statement is the same document for reporting profits and losses, and some businesses refer to the income statement as the profit-and-loss statement, or P&L statement. There are several key elements on this document:

• Operating revenue, which accounts for selling products or services
• Net and gross revenues, including total sales revenue and remaining revenue after subtracting costs
• Nonoperating revenue from accrued interest, investment returns, royalty payments, capital gains

• Primary expenses, including cost of goods sold (COGS), depreciation and selling, general and administrative costs (SG&A)
• Secondary expenses, like debt or loan interest, asset loss and capital loss

Cash flow statement

The cash flow statement is important for measuring the efficiency with which companies generate cash to pay down debts. Documentation of cash flow also encompasses how well businesses fund operations and investments, showing the ongoing activities that generate revenue to support expenses. Accurate cash flow statements are important for understanding the efficiency of current practices, spending activities and revenue generation.

The cash flow statement can also provide investors with valuable insight into whether a business presents a higher investment risk. Unlike the balance sheet and income statement that require some calculations to record financial values, the cash flow statement typically comprises three key elements:

• Operational activities, including accounts receivable and payable, inventories, wages, income tax and cash receipts
• Primary investment activities, including the generation and use of investment earnings, asset sales, issued loans or credit and payments from acquisitions or mergers

• Secondary investment activities, including fixed-asset purchases for equipment, office space or property
• Financing activities, including stock repurchases, payable dividends, debt repayments and issuance, cash from investors and cash payments shareholders

Statement of shareholder equity

Shareholders' equity typically appears on the balance sheet, however, larger corporations may document these activities on separate statements. The statement of shareholder equity serves this purpose and includes the amounts key stakeholders and owners invest in a company. These investments include company stocks and securities, which pay out dividends at certain periods. Additional items on a statement of shareholder equity that companies generally review include:

• Common and preferred stock sales and repurchases
• Purchased treasury stock, minus any reissued treasuries during the reporting period
• Retained earnings after subtracting dividends and losses
• Accumulated income, including incomes from unrealized capital gains, minus capital losses

Who uses financial reports?

Financial reporting is an integral process across almost all industries. Businesses and corporations depend on analysis and review of financial documents to make decisions and gain financial backing. Financial institutions also rely on financial documentation to monitor compliance, issue credit and assess profitability and performance. Consider several groups and professionals who use financial reports:

• Investors, shareholders and creditors: Investors and shareholders have ownership of company stock and review financial reports to assess how companies generate profit. Creditors also use data from financial reports to understand how well companies pay off debts and invest credit to generate business growth.
• Executive managers: Executive directors and teams use financial reporting systems to review performance and revise documentation. Financial reporting also supports executive decision-making, which companies use to establish goals and departmental objectives.

• Regulatory institutions: Regulatory entities also gather and review business data from financial reports. Government entities, including the IRS and the and Securities Exchange Commission (SEC) monitor the compliance of financial reporting activities for tax and revenue documentation.
• Industry consumers: Financial reporting is also important to educate consumers about company activities and create transparency in the market. Open communication about earnings, investment activities and charitable donations helps inform customers and can drive additional sales.
• Unions and employees: Union organizations that represent employees monitor financial reporting to ensure members receive fair wages and treatment in the workplace. Financial statements are also beneficial to employees who can review reports to gain insight into the financial stability and long-term profitability of their companies.

Who regulates financial reporting?

Regulatory entities, including the SEC, IRS and Financial Accounting Standards Board (FASB) establish standards that outline protocols and required practices relating to financial activities and documentation. The SEC is responsible for overseeing capital markets and sets forth regulations for investment activities in stock markets. Depending on the type of business, capital market activity and funding, the SEC requires public companies and market participants to disclose financial information regularly for investors to review.

The FASB is a private regulatory entity that establishes and monitors the Generally Accepted Accounting Principles (GAAP). The GAAP provides a framework for financial processes that supports efficiency in reporting and ensures regulatory compliance with other standards.

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