The main objective of the financial reporting for any company is to present the necessary information with respect to the financial position of the company, the cash flow position of the company and the various obligations of the company that is relevant for its users for tracking business performance, understanding financial health of the company as well as for informative decision making.
Objectives of the Financial Reporting
The following financial reporting objective provides an outline of the most common type of goals of the financial reporting that are present. It is not possible to provide all the examples of objectives that address every variation of every situation, as there are multiple such objectives.
Below are the top 4 objectives of financial reporting –
- Provide Information to the Investors and the Potential Investors
- Track the Cash Flow in the Business
- Information About the Accounting Policies Used
- Enable the Analysis of the Assets, the Liabilities, and the Owner’s Equity
Let us discuss each of these in detail –
Top 4 Objectives of Financial Reporting
#1 – Provide Information to the Investors and the Potential Investors
Investors of the company who have invested their funds in any business want to know that how much return they are getting from their investment, how efficiently their capital investment is being used, and how the company is reinvesting the cash.
Also, the potential investors want to know how the company is performing in the past where they are planning to invest their funds and whether it is worth investing.
Financial reporting by the company helps the investors and the potential investors in deciding whether the business is worth for their cash or not.
Example
Statement of the Profit and loss shows the amount of net profit earned by the company and the profit available for the shareholders to get distributed as the dividend in the current year as well as details of the previous years.
If the company is earning the right amount of profits and the profit is also increasing from the previous year, then this shows that the company is efficiently working and growing. The investor’s money is appropriately utilized, whereas in case the company is incurring losses, then it shows that the investor’s money is at risk. The company is not able to use it properly.
#2 – Track the Cash Flow in the Business
With the help of financial reporting, different stakeholders of the company can know that from where the cash in the business is coming, where the money is going, whether there is sufficient liquidity in the business or not to meet its obligations, whether the company can cover their debts, etc.
It shows the details about the cash transactions by adjusting the non-cash transactions, thereby determining whether cash in the business is enough all the time or not.
Example
Company A has a significant value of the non-cash transactions. It sometimes has the billions of dollars that it owes to the company, but in cash, the same hasn’t been received.
In that case, the statement of profit and loss is not sufficient always, and that time, statement of cash flows plays a vital role as it provides the details of cash transactions and the cash flow position of the company to the creditors, banks and other stakeholders
#3 – Information About the Accounting Policies Used
There are different types of accounting policies, and various companies can use different policies as per their particular requirements and applicability. Financial reporting provides information about the accounting policies used by the company. This information helps the investors and the other stakeholders in knowing about the policies used in the company for the different aspects.
It also helps to know whether the proper comparison between the two companies is possible or not. Two companies within the same industry can also use two different policies, so the person making the comparison should consider this fact in mind at the time of making the comparison.
Example
There are two companies in the same industry, company A and company B. Company A uses the FIFO inventory method. In contrast, Company B uses the LIFO inventory method to value its inventory.
Now let’s suppose all the other things are equal. The financial statements of company B would most likely show less amount of income because it will have a higher value of the cost of the goods sold. On the other hand Company, A would have lower income and higher inventory.
So, these two companies’ financial statements cannot be compared as they both are using different methods of accounting. One would know about the accounting policies used from the financial reporting disclosures. Thus providing information about the accounting policies used is one of the critical objectives of financial reporting.
#4 – Enable the Analysis of the Assets, the Liabilities, and the Owner’s Equity
By monitoring the assets, the liabilities and the owner’s equity, and any changes in them using the financial reporting by the company, one can know that what it can expect in the future and should be changed now for the future. It also shows the availability of resources by the company for future growth.
Example
There is a company A ltd., manufacturing the bottles in the market. It got an order to manufacture and deliver a massive quantity of bottles in the next year. Now, the management of the company wants to know whether it has sufficient assets for the manufacturing of the products so that it can meet with the existing demand of the bottles in the market along with fulfilling the new bulk order on time.
So, with the help of the financial reporting, the management of the company can get to know the capacity of the existing assets and whether the company requires any additional resources for the purpose of fulfilling the new order received by it.
Summary of Financial Reporting Objectives
The objective of financial reporting is tracking, analyzing, and reporting the income of the concerned business. The purpose of the financial reports is to properly examine that whether the resources are appropriately used or not in the business, what is the company’s cash flow along with the details of cash flows from each activity of business; how are the performance and the financial health of the business. This reporting helps the investors of the company in making informed decisions about the business in which they invested or thinking of investing is operating.
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