Every business leader needs accurate financial reporting to manage their organization. But since no two companies are alike, the precise composition, purpose, and utility of these reports can seem mysterious. So, let’s discuss what financial reports are, how we use them, and the statements you should expect from your finance and accounting team. Then, I will share some tips for developing an effective reporting process and a free download.
What is Financial Reporting?
Financial reporting is an essential accounting function for periodically delivering critical information about a company’s economic performance. First, accountants compile details about your account balances, financial obligations, and inflows and outflows of cash into standardized reports. Then, ideally, your finance team analyzes this data and combines it with your projections to develop digestible and actionable insights.
Financial reporting is a necessary (and sometimes legal) obligation for businesses of every size. Some small companies can get by with little more than the basic reports provided by accounting, which give a snapshot of where you have been and where things stand today. However, organizations with complex operations or that want to grow and scale must become more sophisticated, so I will explain how reporting can evolve later in this post.
What is the Objective of Financial Reporting?
The primary purpose of financial reporting is to provide crucial insights to your executive team for effective decision-making while also capturing the data you must share with external entities. But it doesn’t stop there. Below are some common ways you might use financial information.
Monitor Your Company’s Current Financial Health
Basic financial reporting provides visibility into where you have been and the current state of your company’s finances. When your executive team reviews this data each month, they should be able to answer key questions that will help them run the business, given the current condition of your operations, such as:
- Is our company profitable?
- Have we hit the objectives set forth by our investors or lenders?
- How are we managing our growth? Do we need to find better ways to scale?
- Are we collecting receivables promptly? If not, how is this affecting our cash flow?
- Is our financial structure healthy, or is our mix of debt and equity imbalanced and a potential red flag to future creditors and investors?
Forecast Trends and Prepare for the Future
Knowing how your company is doing right now is great. But the real power of using financial reporting for decision-making lies in analyzing the trends and combining the data with projections so you can spot problems or opportunities. In other words, given where you have been and where you are today, can you accurately predict where you are heading and address potential issues before they occur? For instance, savvy business leaders will use this information to answer questions like:
- If we are not profitable yet, when will that occur?
- Are we on track to hit our revenue or customer acquisition targets?
- Will we be able to stay within budget?
- Do we have enough cash to pay our suppliers and employees in the coming months? If not, how much do we have left?
- If we close a big deal in the pipeline, do we have the resources to fulfill that obligation?
Analyze the Potential of Proposed Initiatives
Once you have taken the step of building in your projections, you can also run what-if scenarios to model the potential effects of proposed initiatives. Once again, this improves your ability to make sound business decisions, such as:
- Should I borrow more money to invest in marketing, people, or machinery?
- Can I afford to acquire a particular company or expand into a new market?
- Would it be better for us to grow organically by increasing our output or investing in advertising, or would we be better off seeking a merger, acquisition, or partnership?
- If we invest in new technology, how long will it take to pay off?
- And, when times are tough, how much cash would we save if we eliminated a certain percentage of our workforce?
Communicate Important Data to Company Stakeholders
Your finance and accounting team will use the data contained within your financial reports to communicate needed information to both internal and external stakeholders. For example, department heads and certain managers will use financial data to inform their decisions about discrete areas of your business. And employees will look to company performance for motivation. A healthy business suggests career and earnings potential, especially if your compensation plans include distribution of profits or equity in the company.
External stakeholders could include current and potential investors and creditors that expect to evaluate a company’s financial position upfront and regular reporting throughout your relationship. And sometimes, you will need to share financial data with vendors, suppliers, or even customers to assure them that you can meet your obligations. Finally, let’s not forget about your Board of Directors, which will expect high-level reporting and insights at your quarterly board meetings.
Manage Compliance with Regulatory Agencies
As we alluded to earlier, you may need to use the data generated by financial reporting to meet the legal obligations of doing business. For example, the Internal Revenue Service (IRS) requires that you submit these details when filing taxes. And, if you’re a public company, you must file reports with the Securities and Exchange Commission (SEC) that include financial disclosures. In addition, depending on your industry, you may also be subject to financial reporting requirements by other regulatory organizations.
I could go on, but clearly, developing a watertight system for financial reporting is in every company’s best interest. So, what types of reports should you expect from your finance and accounting team?
What Types of Financial Reports Do You Need?
Financial reporting occurs on a monthly, quarterly, and yearly cycle, and the precise contents of these reports can vary, depending on the audience. For example, when submitting historical reports to a potential lender, you typically only provide a high-level snapshot of your current financial situation. Most lenders do not consider financial projections as part of their underwriting process since they want to see a historical track record and how that impacts your ability to repay the debt. In this case, an appropriate financial reporting package would include the following:
Income Statement
An income statement (a/k/a a profit and loss statement) shows an accounting of your organization’s revenues and expenses for a certain period of time, along with (you guessed it) your net profits (or losses). It is a simple report that documents the items in each revenue and expense category. And you will typically see subtotals for gross profit, operating income, and income before taxes. Then it shows a final tally (your net income) at the bottom.
This report provides insight into the company’s productivity and profitability while also serving as a benchmark for comparing its financial health.
Balance Sheet
A company’s balance sheet, on the other hand, documents an organization’s assets, liabilities, and shareholder’s equity (a combination of investment made into the business and profits earned to date, i.e., retained earnings, as reported on the income statement). It provides a snapshot of where things stand at a particular point in time. Put another way, it shows how much you have, how much you owe, and the company’s net worth on a specific date.
As a stand-alone document, this report speaks volumes. For instance, potential investors and creditors can use it to see whether you have a healthy balance of debt vs. equity or if you are an investment risk. They can also combine it with other financial statements to evaluate your company’s current financial stability.
Statement of Cash Flows
The cash flow statement (a/k/a statement of cash flows) shows all sources and uses of cash for your organization, broken down into three main areas:
- Operational Cash Flow – changes in cash due to selling something or paying someone, i.e., the essential functions required to operate your business.
- Cash Flow from Investment Activities – cash activity necessary to pay for or sell equipment or buy/sell the assets you need to run your business (e.g., manufacturing equipment).
- Financing Cash Flow – cash changes resulting from obtaining credit, securing an equity investment, making dividend payments, or paying off loans.
This report is not as helpful as the prior two reports without more context, but those with financial acumen can still glean insights. For instance, if a company has positive cash flow, that is a sign that it is healthy. Conversely, if operations are not generating enough cash to pay for the business’ obligations, this suggests a problem.
There are plenty of other financial statements that can be useful, depending on your business. For instance, if you run a B2B company, you might want accounts receivable and accounts payable aging reports. When bills and invoices sit on the books for too long, business owners must ensure that it doesn’t get out of hand, resulting in a cash flow “crunch.”
Also, the financial reports listed above are just a starting point. Your executive team or board will need more than just a simple snapshot. Instead, they will need complete financial reporting and analysis of your current and historical financial data. And ideally, you will combine this information with projections and insights to guide their decisions.
Reporting packages for your executives or board will likely include all three statements above and reports specific to your business, along with the following:
An Executive Summary
An executive summary typically precedes any financial reporting documents presented to your executive team, board, or shareholders. It is a written analysis describing what occurred since the last report (as revealed in the numbers) and the finance team’s recommendations.
KPI Dashboard
A Key Performance Indicator (KPI) dashboard is a one-page document showing the high-level metrics that demonstrate your company’s health. It provides quick insight into whether your company is on track for achieving its goals, enabling you to spot issues before they spin out of control.
However, don’t let the simplicity of the KPI dashboard fool you. It is simply a summary of the most important data presented in your other financial documents. Therefore, you must update your numbers each month or quarter to keep this report accurate and useful.
Cash Flow Forecast
A cash flow forecast is a detailed report that shows your company’s current cash position and a projection of its future cash position based on anticipated revenues and expenses. This document complements and extends your statement of cash flows report by projecting it into the future, making the data more valuable and actionable. It can help you get ahead of any cash flow problems that might inhibit your ability to run your business.
How to Build a Reliable Financial Reporting Process?
So, how can you build a financial reporting process from the ground up? Well, this is not just a one-time thing. It is a function that can start simply then evolve with your organization, and it is helpful to think ahead. Below are some tips to get you started:
- Hire an accountant and work with them to identify where your data lives and to select and implement a tool for managing that data and generating reports. Be sure to pick technologies that can grow with your organization over time, integrating with whatever else you have in play, such as your inventory management solution.
A simple Excel spreadsheet can often serve this purpose for a while if you are comfortable uploading and downloading data to and from other systems. I would encourage you to download our monthly financial report Excel template as a starting point. - Develop policies and procedures for ensuring that your data is accurate. Unfortunately, problems with data tend to compound over time, which will affect your ability to make decisions, so I recommend that you get on top of this as early as possible.
- Secure the services of your CFO (or hire a fractional CFO) to own the process of financial modeling and analysis for your executive team. Although an accountant can do much of the legwork and prepare basic financial statements, you will need someone with more experience to analyze those statements and develop actionable insights.
- If you decided to go with the Excel spreadsheet in Step 1, start thinking about technology solutions for doing this work as your company grows. Your needs will become more complex as you scale. However, if you are careful with the steps above and have a great CFO, this should be a relatively simple transition.
Financial Reporting: Final Thoughts
Financial reporting is a crucial function for your organization. It is how you get the data and insights you need to make decisions and communicate about your economic situation to other parties. Although you can certainly start simple and evolve as your company grows, I would encourage you to invest in getting this done right. In addition, I would welcome you to explore our fractional CFO services should you need help.
