What Is Financial Reporting?

Financial Reporting Explained in Less Than 5 Minutes

Accountant using calculator and two computers for financial reporting
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Financial reporting is the process of creating and sharing documents about the financial status of your company with stakeholders such as shareholders, creditors, or potential lenders. All businesses must prepare financial reports; it’s required by law, and the IRS uses financial reports to check on your tax payments.

Even if you’re a sole proprietor who never shares financial information with anyone but your accountant and the IRS, financial reports are the main ways to determine whether your business is truly profitable. Learn more about the four most important financial reporting documents and how they work.

Definition and Examples of Financial Reporting

Financial reporting is the process of completing and sharing specific documents to show your profits, losses, and expenses. Financial reporting is required by law, although there are slightly different requirements for sole proprietors and nonprofits.

There are three basic documents that are always included in a financial report: a balance sheet, a profit and loss (P&L) statement, and a statement of cash flow.

If your business is larger than a single individual, you may need to prepare a Statement of Retained Earnings, which is also called a Statement of Owners’ Equity. Additional documents, such as auditor reports and shareholder minutes, can also add to the value of financial reporting.

How Financial Reporting Works

Financial reporting documents must be prepared in the same order. They should also be prepared in the U.S. according to Generally Accepted Accounting Principles—or GAAP. GAAP is the accounting standard developed by U.S. governmental agencies to ensure consistent and ethical financial reporting.

Financial reporting forms are always prepared in the same order:

  1. Profit and loss, also known as the "income statement"
  2. Statement of retained earnings, also known as "statement of owners’ equity"
  3. Balance sheet
  4. Statement of cash flows

Profit and Loss Statement

If you’re running a small business, especially a service business that has no costs for manufacturing, you’ll find it pretty straightforward to prepare a profit and loss statement. It’s simply a comparison of your costs versus your income. You then subtract taxes, depreciation, and any interest you’re paying, and the remaining amount is your net profit. The rest of your financial statements will be based on your profit and loss statement.

Owners’ Equity

Once you’ve figured out your net income, you can create your owners’ equity statement. The process involves adding any new capital you’ve received (such as loans or investments) and subtracting any withdrawals (such as payments you make to yourself). The owners’ equity statement is usually quite short, and is most important for larger companies with stockholders.

The owners' equity report can have a significant impact on the stock price for publicly listed companies.

Balance Sheet

The balance sheet is sometimes described as a “snapshot” of your company’s financial health, because it shows your assets, liabilities, and equity at a single point in time. Usually prepared quarterly, the balance sheet represents the actual “book value” of your company at a particular moment. It contains assets, liabilities, and owners’ equity.

Balance sheets are used in a variety of ways.

  • Internally, they help company managers determine the ongoing financial health of the business. If there are trending issues, balance sheets can help managers pinpoint the problems and resolve them.
  • Externally, they are used as a tool to help potential investors or lenders determine the financial status of the company. A company with a healthy balance sheet is more likely to attract funding.
  • Balance sheets may also be used by auditors to determine that a company is following GAAP and all appropriate accounting laws.

Cash Flow Statement

How much money is coming into and going out of your business? A cash flow statement displays how your business operates over time, taking in revenue and paying off creditors as you go.

A cash flow statement shows whether your expenses and payments relate to operating, investing, or financing activities—usually in that order.

These statements are important because they relate to the movement of money, not to net income or expenditure. In addition, cash flow statements do not include any money that will come in or be spent on credit.

Can Your Business Benefit from Financial Reporting?

Not only can your business benefit from financial reporting, it is legally required to do at least some financial reporting. If you produce such reports, you will know whether your business is truly profitable, and be able to pinpoint variances with cash flow over time, addressing them before they become a problem.

You’ll also know how much you’re earning and spending in different categories. Financial reporting can help business owners attract investments or qualify for business loans, and communicate effectively with stakeholders and stockholders. In addition, you will have the documents you need to be audited properly and to pay the correct amount in taxes.

Key Takeaways

  • Financial reporting is the process of preparing and sharing specific documents about the financial status of your business.
  • All businesses of any size should prepare financial reports.
  • There are four basic financial reports most businesses prepare: profit and loss, cash flow, owners’ equity, and balance sheet. 
  • Financial reporting gives your business important tools for managing cash flow and attracting investments and credit.
  • Larger businesses use financial reports to communicate with stockholders, and certain financial reporting documents can have a significant impact on stock price.