Why Are Financial Reporting Important for Small Businesses?

Oliver Lee
September 12, 2022
|
8
 Mins Read

As a business owner, you must stay on top of the following aspects:

  • Selling your goods or services
  • Managing Your Employees
  • Obtaining funding and making investments
  • Developing business plans
  • Make sure you're not violating any laws while doing all of this and more

What is the ultimate goal? Profitability. Excellent financial standing.

Knowing your financial status is important to external entities (the government, financial institutions, and investors) and internal stakeholders and decision-makers within your organization. Financial reporting requires the creation of statements and reports for these stakeholders. Your financial reporting requirements as a small business owner differ from those of large, publicly traded companies. Therefore, this article will explain everything you must know about financial reporting for your business.

First, will discuss what financial reporting is.

Financial Reporting - Definition

Financial reporting is a standard accounting practice in which financial statements are used to disclose a company's financial information and performance over a specific period, typically on an annual or quarterly basis. In layman's terms, a financial report is essential for understanding how much money you have, where it is coming from, and where it needs to go. Furthermore, financial reporting is necessary for management to make sound business decisions based on company financial health information. Finally, potential investors and banks will use your company's financial reporting to determine whether or not to invest or lend you money.

The next segment will discuss the Financial Statement Types

Financial Statement Types

A financial statement is a written report that shows how a company makes money and what it does for business. The government, accounting firms, or independent accountants check these statements for accuracy. The four most important financial statements in a financial report are:

  • Income statement
  • Balance sheet
  • Statement of retained earnings
  • Cash flow statement

In the following sections, find out what each statement means and how it helps people who use financial statements.

Income Statement

A profit and loss statement (income statement) summarizes a company's revenue, expenses, and profits. The income statement essentially shows how much money a company earned or lost during a given period and ultimately determines a company's net income or "bottom line."

The Balance Sheet

The balance sheet reflects an organization's financial position as of a specific date. The balance sheet is also a snapshot of a company's financial health because it only presents financial data for a single point in time rather than a period.

Statement of Equity Changes

A statement of changes in equity, or a statement of retained earnings, is an accounting report that details an entity's equity changes over a single accounting period. Earned profits, dividends, capital investment, capital withdrawal, net loss, and other components are among the changes reflected in the document.

Statement of Cash Flows

A cash flow statement (CFS) shows how much money is coming in and going out of a business. The CFS helps stakeholders understand how a company operates and manages cash to pay off debt, fund current expenses, and make future investments.

Now, will discuss Why Are Financial Statements Important for Small Businesses?

Why Are Financial Statements Important for Small Businesses?

It isn't easy to understand how well a company performs financially without financial reporting. Financial reports are not only important for management or investors to assess a company's financial stability, but they are also required by law for taxes and standard accounting practices. The following are the top five reasons why financial reporting can help your small business:

Managing Finances

Financial reporting is based on rules that ensure complete and accurate bookkeeping of your cash and financial transactions. Everything is chronologically recorded as part of a systematic process that tracks every facet of your transactions. You consistently have a 360-degree view of the money flowing in and out of your business, as well as any receivables, payables, past-due customer invoices, profit generated, losses incurred, inventory count, and so much more.

Taxation

The Internal Revenue Service (IRS) analyzes your accounting reports to ensure that you pay the correct taxes. To best comply with the IRS's legal tax requirements, you must record every transaction within the business. Simultaneously, by using financial reporting to keep accurate records of all your business expenses, you can debit them from your taxable income and pay less tax at the end of the year.

Creditors and Investors

A proper financial reporting system is required for investors, shareholders, creditors, and customers to take a serious interest in your business. This can demonstrate to third parties that you run an honest, professional, and dependable business. It also informs them of what they can expect from you in the future. Creditors, for example, must examine your cash flow to assess your company's ability to meet loans, invoice payments, and other financial obligations. On the other hand, investors want to look at your net profit, sales, and margins to determine your company's value and whether the investment is worthwhile.

Analysis and Decision-making

Financial reporting enables businesses to analyze their situation and make informed decisions. For example, businesses can use financial reports to identify best-selling goods and services, growing departments, re-investment opportunities, the current value of assets, and a variety of other real-time metrics and financial insights for decision-making and analysis.

Error Reduction

Transactions in financial reporting are recorded using debit and credit rules. These rules ensure that all debit and credit entries are equal. If these entries aren't equal, you've probably made an accounting error somewhere along the way. Financial reporting makes it simple to identify and correct these errors; all you need to do is look at the balance sheet statement. In addition, if you use online cloud accounting software to automate financial reporting, you'll be notified immediately if any amounts are out of balance.

What is the Purpose of Financial Reports?

Financial reporting aims to provide you with an in-depth analysis of your company's performance. Furthermore, the aid of the report business valuation, future cash flow forecasting, and investment planning. The transactions in your reports demonstrate the economic consequences of your decisions. Some reports are only for internal use, while third parties use others. Financial reporting is scrutinized by investors, lenders, and government agencies. To ensure accuracy, you may need to implement internal controls over financial reporting for outside entities. So, use the same method for each report you create. This allows you to compare figures from various reports easily.

Financial Reporting Regulations and Requirements

Financial reports for public and private firms in the United States must adhere to the Generally Accepted Accounting Principles (GAAP). In contrast, most international companies (IRFS) use the Internal Reporting Financial Standards. While both accounting frameworks provide standard rules and guidelines, the two financial reporting systems differ slightly. Although the IFRS is still in its early stages, the consensus is that it enables multinational corporations to issue short, clean, and reader-friendly financial reports. On the other hand, US GAAP requires financial reports to be much more detailed and adhere to a distinct set of rules and guidelines. In addition, several initiatives are underway to merge or reduce the differences between the two frameworks. However, despite these distinctions, both systems provide a standard framework for producing accurate and consistent financial reports.

Tips for Better Financial Reporting

  1. To eliminate errors and inconsistencies, consolidate your financial data into a single spreadsheet or software.
  2. Log every dollar that comes in and out of business, even if it's a small and insignificant purchase. Recording everything is critical for attracting investors, paying fewer taxes, and remaining legally compliant.
  3. Keep track of all receipts and sales invoices you receive throughout the year to balance your accounts at the end of the year easily.
  4. Create a standard chart of accounts for each transaction in which the company is involved.
  5. Open a new business bank account to separate your personal and business finances.
  6. Consider opening a second savings account into which you deposit a percentage of your business's earnings every month.
  7. Make monthly bank account and credit card statement reconciliations to keep potential errors out of your books.
  8. For your small business's financial reporting, automation is a lifesaver. The more you automate, the more precise your bookkeeping and reports will be, and the more time you'll have to focus on business management.
  9. If your company is growing and taxes have become far too complicated for you to handle on your own, consider seeking aid from an accountant.
  10. Accounting software allows you to access your accounting information from any device with an internet connection.

Conclusion

That's all there is to it! If you've made it this far, the amount of information in this guide may have overwhelmed you. As a result, financial reporting produces financial statements at the end of an accounting period. This practice is supported and standardized by two major guidelines: Generally Accepted Accounting Principles (GAAP) for the United States (GAAP) for the global market. It is essential because it allows you to manage your finances, comply with tax rules, attract investors and creditors, aid decision-making, and reduce the possibility of error. So, if your firm is looking for expert financial reports and analysis services, outsource to Invensis and get access to financial reports at a cost-effective price.

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Article by
Oliver Lee

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