Financial reporting is the catchall term covering everything from your company's cash-flow statement to financial information in press releases. Anything you tell stakeholders, regulators or the public about your finances falls into this category, according to the Accounting Tools website. If your reporting is inaccurate, that can lead to legal trouble, stock prices dropping and bad company decisions.
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Investors rely on financial statements to assess a company's worth, while management relies on internal financial reports for sound decision making. Inaccurate reports can lead you to make bad decisions or make your company look less valuable than it is. They can also land you in legal hot water.
What is Financial Reporting?
The core of financial reporting, Accounting Tools says, is your company's financial statements: the balance sheet, the income state and the cash-flow statement. It also includes footnotes on the statements that provide more information about specific topics. In addition, your shareholder reports, any investor prospectus and whatever financial information you post on your website also count as financial reporting.
If your stock is publicly held, you have a few more reporting categories:
- Forms 10-Q and 10-K, which you file with the Securities and Exchange Commission
- Press releases containing financial information about the company
- Earnings calls in which management discusses corporate finances
Most financial reporting follows an established accounting standard such as Generally Accepted Accounting Principles (GAAP). The Securities and Exchange Commissions requires financial statements from publicly traded companies conform to GAAP, Business News Daily says. Following GAAP doesn't guarantee the statements are accurate, so companies also have to undergo annual audits.
How Financial Reporting Goes Wrong
Companies sometimes commit fraud in their financial statements, misrepresenting the company's financial health to impress investors or hide taxable income. However even a 100 percent ethical business can screw up their reports, Financial Management says. It's not just a matter of mistakes: Not reading or analyzing your bookkeeper's reports means you're not getting much use of them.
- The reports lack comparative data showing, for example, how this quarter compares to last quarter or how actual spending compares to the budget.
- Reports that do include comparative data leave it to the readers to interpret. A report that shows monthly sales revenue for the past year but doesn't translate the differences into percentage requires the readers to make the calculation. They're more likely to get it wrong or misinterpret what they're reading.
- Your bookkeeper doesn't follow GAAP. For example you and the bookkeeper know one of your customers won't pay up, but you keep that knowledge in your heads instead of adjusting accounts receivable.
- You receive internal financial reports, but you don't read them. You can't spot any discrepancies or oddities in the bookkeeping if you don't look for them.
- You read the reports, but don't analyze them. If there are negative trends such as accounts receivable taking longer and longer to pay, you need to spot them before you can identify the problem.
- Not monitoring cash flow closely. Even if your income is good, poor cash flow means you can't pay your bills. Your accounting team needs to update the cash-flow statement even more frequently than other forms of financial reports.
Risk Management says even though large companies often use automated systems to track and record data, the systems can still generate inaccurate reporting. Multiple people making multiple data entries, sometimes in multiple systems, creates errors and inconsistencies. It's not always easy to identify the source of the data and verify its accuracy.
Bad judgment is another issue. Even under GAAP, some issues aren't purely a matter of crunching numbers. Figuring how to expense R&D or to value your company's goodwill are among the many matters that require judgment calls. Those calls won't always be right, particularly close to the end of an accounting period when everyone's rushing to close the books.
Consequences of Bad Reporting
One consequence of bad reporting, Risk Management says, is wasted time. With a lot of human error and data flowing in from multiple sources, your finance department may have to spend hours or days each quarter reconciling financial data throughout your organization. That can add up to a lot of salary spent fighting financial-reporting fires.
Another consequence is that inaccurate information in internal reports makes it harder to make good decisions. Companies rely on financial data in budgeting, forecasting and developing performance indicators. If sales metrics and R&D numbers are off, even if they don't actually violate GAAP, your projections and budgets may be off, too. If your reports understate your debt load, you may discover you're deeper in the red than you thought.
Micronet says misinformation in reports can leave you blind to problems where accurate reports would have been a red flag. Errors can also hurt in other ways until they're corrected: Exaggerated profits can lead to higher taxes, while underestimated profits make your company looks less valuable.
If you issue a statement of earnings, then have to restate them later because of errors, that's not good either. Your stock price may drop, your reputation takes a hit and it may become tougher to obtain capital. There's also the risk that the errors in your reporting are material enough to violate GAAP. If you're a CEO of a publicly traded company, you have to sign off on the accuracy of your financial statements. It's better if the SEC doesn't discover major problems after you've signed.
In 2019, for instance, the SEC said Hertz would have to pay $16 million in penalties, a decision the car rental company signed off on. SEC said Hertz' accounting decisions had been driven by a desire to meet budgets and earning estimates and included multiple misstatements of material facts. Hertz did not admit to any errors, but agreed to pay the penalty.
Consequences of Bad Auditing
External audits are one tool for keeping your financial reporting in line with reality, Inc_._ says. In a financial statement audit, the outside auditor reviews your statements to see if they comply with GAAP standards. That includes checking that your internal controls to prevent errors and fraud work as they're supposed to.
Several audit scandals in the 21st century have demonstrated that auditors don't always do the job right, Strategic Finance says. Some accounting firms have found the real money is in consulting and advising business, and the desire to win clients creates an auditor bias against criticizing them. Where elements of financial reporting are based on C-suite opinions, auditors may end up deferring to management's judgment instead of scrutinizing it.
The consequences of audit failure can be severe. If auditors don't catch inaccuracies in your financial reporting, the problems may grow catastrophic, steering a company to collapse. Unacknowledged liabilities can build up until dealing them becomes a serious problem, even if the company survives.
