A strong financial reporting system is comprised of different types of financial statements to provide a picture of where a business stands financially. This is important for all businesses.
Understanding your finances as a business owner is essential to running a successful company with lots of longevity. However, not every business owner has the same amount of financial reporting knowledge. Gaining familiarity with different financial reports — including the income statement, balance sheet, statement of changes in equity and cash flow statement — is key to understanding the financial health of your business.
Learning about each type of financial report can position you to find opportunities, spot warning signs and ultimately maintain a healthy and profitable business, in both the short and long term.
What is financial reporting?
Financial reporting is the process of using financial statements to record, track and determine a company’s financial performance over a period of time. Reporting tracks funds coming in and going out of the business.
The time period you choose to use can vary from weeks to several years, depending on how you’d like to track your business’s financial performance, and what you seek to gain from the reports. It’s up to you as the business owner.
Ultimately, financial reporting is a strong way to paint a clear picture of your company’s financial health and its ability to grow. Without financial reporting in place, business owners may be in the dark as to how much money they have, where it’s being spent and what they can do in the future. Additionally, investors and banks may want to see a company’s financial reporting before investing in or loaning money to a business.
Businesses can use several different types of financial statements to get a picture of their finances, and many businesses choose to use several.
Main types of financial reports
Within financial reporting, there are multiple types of financial statements. These financial statements — also commonly referred to as “financial reports” — show a company’s financial details and activities.
Companies commonly use four main types of financial reports as part of their financial reporting: income statements, balance sheets, statements of changes in equity and cash flow statements. Each type of financial statement is a crucial part of the full story financial reporting can tell about a small business.
All of these financial reports can be audited by accounting firms, independent accountants or the government so it's important to understand the purpose of each report:
An income statement includes all income and expenses generated by your business over a chosen period of time. With this financial report, businesses can see the impact of revenue, gains, expenses and losses. Income statements are often prepared at regular intervals, like quarterly or annually, in order to reflect financial trends and comparisons over time.
Also known as profit & loss statements (or P&L statements), income statements are one of the most common financial statements business owners use and one of the most common financial reports requested by lenders and investors. They’re also one of the most critical statements for accurate financial reporting.
Income statements help you determine your business’s financial health, as well as enable you to pinpoint future opportunities, spot potential issues and set future goals.
A balance sheet lists and tallies all of your company’s assets, liabilities and equities, all of which speak to what a business is worth on the given “reporting date,” when this financial information is prepared. Balance sheets are often drawn up on a quarterly or monthly basis.
For business owners, balance sheets are important financial reports because they can help show whether a business is succeeding or failing. Based on the balance sheet, companies can make adjustments to correct issues or continue to invest in success.
For people reviewing a balance sheet outside of the company — for instance, an investor or financial institution — the balance sheet provides important insight into the business’s financial health.
Statement of changes in equity
A statement of changes in equity shows how your company’s retained earnings have changed during a specific period — often monthly, quarterly or annually. This financial report is structured as an equation: it begins with the retained earnings from the beginning of the chosen reporting period, adjusts for items such as net income and dividends and closes with the retained earnings balance for the period.
Statements of changes in equity — also called “statements of retained earnings” — can help business owners and other key stakeholders understand how and why equity is changing over a certain period of time. Mostly, however, this financial report is generally prepared for outside parties like investors and financial institutions. Statements of changes in equity are often appended to an income statement (P&L) or balance sheet.
Cash flow statement
A cash flow statement shows how cash is going in and out of your company during a given reporting cycle. Most often, businesses prepare these statements over a short period, such as a month. Typically, cash flow statements include operating activities, investing activities and financing activities.
Cash flow statements help you see how much cash different types of activities generate, and enable you to make decisions about how to allocate cash in the future. Importantly, cash flow statements can help you and outside stakeholders understand the phase of your business. For instance, they can help demonstrate whether it’s growing rapidly or slowly, and if it's in transition or in decline.
Having a strong understanding of a statement of cash flow can also aid in your ability to anticipate future cash needs and seek the appropriate financing or investment in a timely manner.
Why is financial reporting important?
Implementing a strong financial reporting system is crucial for all business owners, especially if you're looking to build a solvent business that can take you to new heights.
Without a strong financial reporting system, your small business could experience major problems, such as inaccurate financial reporting. Additionally, you may miss warning signs of upcoming financial issues to the detriment of your company; on a larger scale, you could even lose potential investors because of not having an accurate financial picture.
For business owners, a combination of well-prepared financial statements is one of the best ways to correctly gauge risk, success and opportunity. Ultimately, understanding your company by the numbers helps set up your small business for future success.