What is Financial Reporting? A Comprehensive Guide

Financial reporting is a crucial function in every business. Not only is it necessary for meeting regulatory requirements and obtaining financing, but it’s also essential for informing your business decisions.

Let’s further explore what you should know about financial reporting as a small business owner, including what it entails, why it matters, and how to go about it.

What is financial reporting?

Financial reporting involves documenting your business’ financial data and sharing it with various stakeholders. That primarily revolves around your financial statements, which summarize your company’s financial performance and position.

You’ll need to have both internally and externally oriented financial reporting functions. Internal reporting processes should help business managers meet tax obligations and make better-informed business decisions.

Meanwhile, external reporting processes should help prospective lenders, investors, and business partners assess their interest in working with you. If your business ever becomes publicly traded, you’d also have to engage in it when disclosing data to existing shareholders.

Notably, your accounting methods may differ depending on the end user of your reports. For example, publicly traded companies must prepare their financial statements in accordance with Generally Accepted Accounting Principles (GAAP), but privately held small businesses can use the less-restrictive income tax basis of accounting.

Types of financial reports.

Financial reporting revolves around the preparation of financial statements. That primarily refers to the balance sheet, income statement, and statement of cash flows. Here’s what you should know about each one.

Balance sheet

The balance sheet is a financial statement that captures your business’ financial position at a fixed point. More specifically, it summarizes your company’s assets, liabilities, and equity on a given date, such as the end of a quarter or calendar year.

In accordance with the accounting equation, the balance sheet has two distinct parts. The top section typically presents your company’s assets. These are the resources your business owns with positive economic value (Ex: cash, inventory, and equipment).

In the lower section, the balance sheet displays your company’s liabilities and equity. Liabilities refer to the obligations your business owes to other parties, such as credit card balances and business loans. Equity represents investments into the company from owners and investors, plus any profits left undistributed from previous years.

Income statement

The income statement, sometimes called the profit and loss statement, documents your business’ performance over time. More specifically, it summarizes the revenues, expenses, and net income your activities generate.

Revenues refer to the gross receipts you earn by selling your products and services, while expenses are the costs you incur while running your operation. Your net income or loss is the difference between your revenues and expenses and represents the ultimate financial result of your activities.

Cash flow statement

Like the income statement, the cash flow statement provides insight into the results of your business’ activities over time. However, it exclusively tracks those that impact your company’s cash balance.

The cash flow statement sorts these cash inflows and outflows into the following three sections based on their primary purpose:

1. Operating – These are cash flows that your business generates through its core business operations, such as collecting revenue and paying rent expenses.
2. Investing – These include the cash flows from buying, owning, and selling investments and non-current assets. For example, buying equipment is an investing cash outflow, while selling securities is an investing cash inflow.
3. Financing – These refer to the cash inflows and outflows from your business’ debt and equity financing activities, such as selling stock in the company or paying back an outstanding loan balance.

After breaking out the inflows and outflows your activities have generated, the cash flow statement culminates in your business’ current cash balance.

The importance and objective of financial reporting.

As a small business owner, it’s easy to get caught up in your day-to-day responsibilities, but you can’t afford to ignore your financial reporting. Whatever your business’ circumstances, this function is critical to your long-term success.

At the very least, you must perform sufficient financial reporting to meet regulatory requirements. For privately held small businesses, that primarily refers to calculating your annual federal and state tax liabilities and fulfilling those obligations, which requires having accurate financial statements.

Typically, the next most significant external reporting concern is sharing financial data with prospective creditors and investors. They’ll always want to investigate your business’ finances to some degree and determine whether you’re a safe investment before offering you financing.

For internal stakeholders, financial reporting is more about empowerment through increased insight into various aspects of your business’ financial health. Managers and employees often need that data to perform their duties effectively.

For example, say you review your year-end balance sheet and learn that cash reserves are significantly lower than at the end of the previous year. You can tell your marketing manager to review the income statement to find any higher-than-expected marketing costs and tighten their budget.

Don’t neglect your financial reporting.

It may not feel as urgent or exciting as closing the next sale, but financial reporting is an essential business function that you should check in on regularly. The longer you let it sit on the back burner, the more difficult it becomes to fulfill your regulatory obligations and extract meaningful insights from your data.

If you don’t have the time or energy to manage your financial reporting, consider using small business software or hiring a bookkeeper to handle the extra responsibilities.

_{Information provided on this blog is for educational purposes only, and is not intended to be business, legal, tax, or accounting advice. The views and opinions expressed in this blog are those of the authors and do not necessarily reflect the official policy or position of Lendio. While Lendio strives to keep its content up-to-date, it is only accurate as of the date posted. Offers or trends may expire, or may no longer be relevant.}