Financial Reporting: Types, Objectives. Benefits and Limitations

It is commonly known that finances are one of the most important things to be kept in mind while running any business. One should know and understand the income, cost, assets, etc of the organisation to make strategic management decisions. Financial reporting is one such way to ensure this.

It means communicating financial information to various stakeholders of the organisation. This usually refers to the issuance of financial statements. This helps in keeping track of the financial position of an organisation. Information is presented in a particular structure to make it easy to understand and comprehend.

Types of Financial Reporting

Financial reporting is done using various means. These include:

1. Issuance of financial statements.
2. Notes to the financial statements
3. Quarterly and annual reports issued to stockholders
4. Prospectus issued
5. Financial information disseminated through the website, press release, conference call etc.

What is a Financial Statement?

Issuance of the financial statement is a very important way to report financial information. A financial statement has three main components -  income statement, balance sheet, and cash flow statement. The balance sheet has three parts, namely assets, liabilities and shareholder’s equity. This gives insights into the financial worth of the company in terms of book value.

An income statement gives information about the revenues earned and cost incurred by the company and hence the net profit or net loss. Finally, a cash flow statement displays the flow of cash from the company’s operating activities, investing activities and financing activities. These statements are further analysed to judge the financial performance of the company, which is referred to as financial statement analysis.

Keeping a journal and ledger is the key step in the preparation of the financial statement. This was traditionally done using accounting books which are now replaced with advanced software. For small businesses, free digital ledger keeping apps like OkCredit have made this task much easier and hassle-free.

Objectives of Financial Reporting

Financial reporting has myriad objectives and purposes. The key objective is to give information to various stakeholders, which helps them in their task and decision-making process. Here is a glimpse:

1. Assisting the management of the organisation to undertake the tasks of planning, analysis and decision making.
2. Enable creditors, investors and other stakeholders to make wise decisions regarding investment, credit etc.
3. If the company is listed, financial reports help shareholders and the general public gain insights into the company’s performance.
4. Giving information about the organisation’s economic resources, whether these are liabilities or owner’s equity and how these change over time.
5. Facilitating audit by giving information to statutory auditors.
6. Look into the interest of employees, government and trade unions and enhancing social welfare and goodwill.

Financial Reporting Benefits

Financial reporting is extremely important, both for the company and its stakeholders. Here are some reasons why -

1. It is necessary by law in some cases to report the finances. Thus, it helps the organisation comply with the legal requirements.
2. The role of a statutory auditor is to audit the financial statements of a company and give their opinion. Financial reporting makes this task easier.
3. Various stakeholders use financial reports to undertake the task of financial planning, analysis and decision making.
4. Through financial reporting, organisations can raise capital for their operations.
5. Financial reports are also useful for bidding, labour contracts etc.
6. The future earning capacity of the organisation may be predicted.
7. Through analysis of these reports, managerial efficiency may be assessed. Weak points can be found out and necessary steps can be taken to improve them.
8. Comparison between firms can take place with the help of financial reports. This also helps in the case of mergers and acquisitions.
9. Most importantly, complex information and various transactions are summarised so as to give a much simpler view of the financial position of an organisation.

Limitations of Financial Reporting

Financial reports have some limitations in the scope of the information they provide, the way they are prepared, cost, etc. Here are some major limitations:

1. Financial reports only take into account information that is financial in nature. This means information that can be expressed in terms of money. Quantifiable non-financial information can also be disclosed in addition to the financial information, like the number of employees etc. Financial reports don’t take into account non-quantifiable non-financial information like employee satisfaction, quality of management. This information is vital in judging the performance of a company, but it can’t be reported in terms of money.
2. Amounts reported are often estimated rather than exact measures. These may be based on rules and conventions. Hence, we can't be sure of the precision of the financial report. It is an estimation of the true financial picture of the organisation.
3. Financial reporting is historical in nature. It gives details about the transactions and events that have already taken place. Sometimes, future expectations and estimates are also included, but analysing past trends are not enough to make predictions about the future. Users of this information should also study other factors that may affect the future outcome and form their own predictions of the future and its relation to past events.
4. Financial reports alone aren’t enough to make economic and business decisions. Other factors like the economic scenario of the country, political events etc should also be looked at before making any decision about the organisation.
5. Financial reporting comes at a cost. This includes the resources used to provide the information and the potential harm caused to the company after disclosing the information. The time used to understand and make sense of the information is also a cost.

Conclusion

Financial Reporting and analysis have both pros and cons. Different people may disagree on whether the benefits outweigh the cost or not. Some people also argue that amounts and facts are portrayed in such a way as to make the organisation look good. Hence, it does not show a true picture of the company.

Nevertheless, it is important to disclose a company’s financial information to enhance decision-making and transparency. It enables investors, bankers and lenders to judge whether to invest in or lend to the company or not. Most importantly, managers of a business cannot ignore financial information while taking important decisions.

Also Read:

1) How to Start a DJ business for Occasions in a Small Town?
2) How to Start a Lawn Care Tools and Gardening Tools Business?
3) How to Start a Logo Design Business?
4) OkCredit: All you need to know about OkCredit & how it works.

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FAQs

Q. What is financial statement analysis?

Ans. It means analysing a company’s financial statements to facilitate decision making. Financial information can be evaluated in terms of past, current or projected performance. Several techniques and tools are used to analyse financial statements. These three are most commonly used - horizontal analysis, vertical analysis and ratio analysis.

Horizontal analysis compares line items across two or more years. It is also referred to as time series analysis. Vertical analysis studies the effect of line items on other parts of the business by calculating proportions. In ratio analysis, important ratio metrics like the debt-equity ratio, are used to calculate statistical relationships.

Q. Who are the users of financial statement analysis?

Ans. Users of financial information are, but not limited to, management, employees and trade unions, shareholders or owners or investors, potential investors, suppliers or creditors, bankers and lenders, researchers, tax authorities and customers. Broadly, they can be classified into external and internal users.

Q. What is the difference between financial reporting and analysis?

Ans. Financial reporting and analysis are two different things but are interconnected. The former refers to a document that releases financial statements and other financial information to the public and shareholders. This document usually contains a balance sheet, cash flow, profit and loss statement and other details. On the other hand, financial analysis is the evaluation and study of the organisation and its operation to enhance its performance. Both of these are part of financial management.

Q. Which law in India mandates the reporting of financial information?

Ans. Companies Act, 2013 that replaced the companies act, 1956 governs all aspects of listed and unlisted companies in India. It deals with a variety of issues like corporate social responsibility, mergers, prohibiting insider trading etc. The act also has several rules and regulations concerning completing the financial statement, which has to be followed. Some Accounting Standards (AS) are also made compulsory for the companies to adopt, like AS-3, which governs cash flow, AS-10 for accounting of fixed assets etc.