Proper Financial documentation is crucial for the adequate functioning of a business as it contains all the records and reports of a company’s financial activities. The financial documentation of a company provides insight into the current business position in the market. Also, it helps analyze whether the company complies with the rules and regulations regarding its business. Moreover, it allows the stakeholders to make informed decisions. Financial reports and financial statements are foundational components of financial documentation but are distinct from each other. After reading this article, the reader can distinguish between these.

Common misconceptions and the Importance of understanding the distinction:

Most people think that financial statements and financial reports are the same terms, but these are two different terms and are distinct. A financial statement is a component of a financial report. Moreover, some think that only large companies need to make financial reports. Still, small companies or businesses also need to make financial reports to track their finances, communicate with stakeholders, make informed decisions, and meet company annual compliance requirements.

Individuals need to understand the difference between financial reports and financial statements as they have different purposes and formats, and failing to understand the difference may lead to misinterpretations of a company’s financial status. This results in wrong internal decision-making and affects external communication.

Financial reports are documents related to the financial health of a business, such as its growth, assets, expenses, and equity, etc. some of the common types of financial reports are quarterly or annual reports, external reports, and government reports, etc. on the other hand financial statements are a formal component of a financial report containing information related to business’s finances. Some common types of financial statements are balance sheets, cash flow statements, statements of changes in equity, and income statements.

Financial statements: The core components

Definition:

Financial statements are the components of financial reports and are formal records related to business finances. Financial statements give quantitative data about a company’s finances.

 Purposes of financial statements:

There are several purposes for creating financial statements. The primary purpose of financial reports is to provide an overview of a company’s overall financial status and health. Financial reports help the stakeholders or shareholders make informed decisions and ensure the company complies with all the rules and regulations. Moreover, it also allows the government to create new taxation policies based on the companies’ operations.

Types of financial statements:

Some of the types of financial statements are:

1. Balance Sheet:

The balance sheet is a primary financial statement that provides an overview of the company’s or a business’s assets, liabilities, and shareholder’s equity at a particular time.

Real-world example: According to the balance sheet of ExxonMobil Corporation for the year 2023:

The company’s total assets were $376.3 billion, its total liabilities were $163.8 billion, and its total equity was $212.5 billion.

2. Income Statement

The income statement provides an overview of the revenues, expenses, net income, and earnings per share during a particular time. Its primary purpose is to give insight into how much profit a company obtains, consequently helping the executive management identify its progress. Income statements cover a time range, generally a whole financial year or quarter.

Real-world example: According to ExxonMobil’s income statement for 2023, the company’s total revenue was $344.6 billion, with a total cost of $291.8 billion and a net income of $ 36 billion.

3. Cash Flow Statement(CFS):

The cash flow statement (CFS) provides an overview of the money flow during the fiscal year. It tells how the company spent or earned the money during the financial year. It helps external shareholders identify the company’s operations and current financial position.

Real-world example: ExxonMobil’s cash flow statement for the financial year 2023 generated a positive cash flow of around $55.4 billion.

4. Statement of Changes in Equity

Statement of changes states any change in owner’s equity within a company, which is the difference between assets and liabilities, during the financial year. It gives information such as when a new investor is added. It records many other components, e.g., total income, including profit or loss, the effect of changes in accounting policies, etc. If a company distributes 10% shares of the company, they must subtract it from the current owner equity.

Standardized format and structure:

The financial statements follow a standardized format and structure. The companies are ordered to follow the format to ensure consistency and reliability.

Accounting Standards:

Countries follow some standards to suit their economic systems.

Generally Accepted Accounting Principles (GAAP): Accepted accounting principles (GAAP) are the principles that are used in the United States to ensure the transparency of financial statements.

International Financial Reporting Standard (IFRS): International Financial Reporting Standards (IFRS) are the principles developed by the International Accounting Standards Board (IASB) and used in over 140 countries, including Europe, Asia, Africa, etc.

 Legal requirements and standards:

In most countries, companies must prepare and file financial statements to comply with the rules and regulations set by the government. And those financial statements must be filed according to the legal requirements. In The United States “The Securities and Exchange Commission (SEC) “regulates the financial disclosure of businesses. Likewise, in the UK, it is regulated by the Financial Conduct Authority (FCA); in India, it is regulated by the Security and Exchange Board of India (SEBI).

Financial Reports: The Broader Perspective

Definition:

Financial reports are documents related to the economic health of a business, such as its growth, assets, expenses, and equity; among the common types of financial reports are quarterly or annual reports, external reports, government reports, etc. Financial reports help the shareholders gain insight into the company’s operations and challenges.

Components beyond financial statements:

Management Discussion and Analysis (MD&A):

 In the Management Discussion and Analysis (MD&A) section, the company’s management provides its current performance. The purpose of the MD&A section is to give the external stakeholders a clear understanding of the company’s financial position and performance during the recent fiscal year. Moreover, the management also discusses the challenges and risks faced by the companies and their plans to overcome these challenges.

Notes to Financial Statements:

1. The notes to financial statements provide detailed explanations like balance sheets and income statements. Through these notes to financial statements, the stakeholders can understand the accounting policies, its inventory valuation (either FIFO or LIFO), and financial details of the company in more depth.

 Auditors report:

1. The auditor report is a formal report created by an individual auditor about the reliability of a particular company. Auditor reports help the stakeholders identify whether the financial statement is correct and whether the company complies with all the required standards, e.g., GAAP and IFRS.

Corporate governance report:

1. The corporate governance report explains how they are managed and controlled. Moreover, it states how a company makes decisions and identifies any risks. The corporate governance report is created to ensure the company’s accountability and transparency.

Narrative Elements and Contextual Information:

Financial reports contain narrative elements that help to provide a clear understanding of the company’s performance. Financial reports give a detailed description of the events occurring in the economy and their effects on the company. Moreover, these reports also explain why the company’s financial figures are decreasing or increasing.

Additional Disclosures and supplementary data:

Financial reports also may include some more data as well.

For example, it may include “Environmental, social, and governance (ESG),“ which gives insight into the company’s sustainability practices and the key performance indicators (KPIs) like retention, market share, etc. Moreover, the report may also contain breakdown data based on revenues from different geographical regions and business divisions.

Key Differences between financial statements and financial reports:

Scope and comprehensiveness:

The most significant difference between financial statements and financial reports is that they only provide the essential core quantitative data of the company’s finances, like how many assets it has, how much it earned or spent during a specific time, and the cash flow. On the other hand, financial reports provide detailed quantitative and qualitative data. Moreover, it also includes some narrative details like the auditor’s report, future predictions, and management’s analysis.

Purpose and objectives:

The financial statements give an insight into the company’s financial health. It only tells the company’s current assets, liabilities, and revenues. On the other hand, financial reports give a complete overview of the company, including its past performance and plans. Moreover, the financial statements only provide insight into numbers to help the stakeholders make informed decisions about the company’s financial position, while the financial reports also give the detailed context or reason behind those facts. For example, financial statements only tell whether the company’s revenue is low or high. But, the financial report also gives the reason behind it, along with the strategies and future goals made by the company.

Target audience:

Financial statements are generally used by investors and regulatory bodies like banks and authorities because they focus majorly on the financial position of the companies. On the other hand, financial reports are used by a wide range of audiences, including investors, customers, and the general public too, because they need a more in-depth overview of the company.

Level of detail and analysis:

Financial statements only give brief quantitative data about the company, while financial reports provide detailed qualitative and quantitative data, including its future goals and financial metrics.

Regulatory Requirements:

Financial statements are legally required for almost every country, especially public companies, and are directed to follow specific accounting standards like GAAP and IFRS. On the other hand, financial reports are not legally required. Moreover, they have no strict standards.

Frequency of preparation:

Financial statements are often created quarterly or annually, depending on the regulations, while financial reports are prepared annually as they provide a detailed overview of the company’s finances.

Formats and presentations:

Financial statements must be created according to specific accounting standards, e.g., GAAP and IFRS, while there are no strict standards for financial reports.

Relationship between financial statements and financial reports:

How financial statements fit within reports:

A financial statement is a component of the financial report and provides essential quantitative data for analyzing the company’s financial position. Financial statements play the role of building blocks in making financial reports.

Integration and cross-referencing:

Cross-referencing helps individuals to link the quantitative data of financial statements with qualitative data (narrative insights) of the other parts of reports. For example, if the income statement shows a 20% increase in revenue, then the MD&A section can tell the reason for the revenue increase. So, in this way, by knowing both the qualitative and quantitative data, the stakeholders can quickly identify and evaluate any risks, and the managers can set strategies and plans accordingly.

Complementary nature of financial statements and financial reports:

Depth and context:

Since financial statements only give raw data in numbers, while financial reports give qualitative data with context, they complement each other, help investors in analysis, and make the data more meaningful.

Transparency and accountability: Financial statements and reports show the company’s transparency because they provide the numbers and narrative behind them.

Decision making: By providing both financial statements and financial reports, it becomes easier for the management and stakeholders to make informed decisions because of the comprehensiveness of the information.

Use cases and applications:

There are many applications of financial documentation analysis:

Internal decision-making:

The management uses financial statements and financial reports to make decisions. They get the qualitative and quantitative data through it and identify where they lack and need improvements. For example, A company can use the cash flow statement to decide whether they have enough money to invest in new purchases.

External stakeholder communication:

Financial reports and statements also help to communicate with external stakeholders and investors. Moreover, the investors and stakeholders clearly understand the company’s financial position through financial documentation.

For example, if a company’s annual report shows an increase in its revenue, there is a greater chance that more potential investors will be attracted.

Consequently, this transparency helps build a strong relationship, which leads to further success. Another example is Apple Company. Until the early 2000s, the company was a computer Technology Company, but it changed in 2007 and 2010 due to the introduction of the iPod and iPhone.

Regulatory compliance:

The Company must adhere to standards such as IFRS and GAAP to avoid penalties and fines. Regulatory bodies like the Securities and Exchange Commissions (SEC)“ in the US monitor industries to ensure legal and ethical practices. So, companies must submit standardized audited financial statements regularly. Moreover, it helps enhance the company’s credibility and reliability.

Investment Analysis:

Proper financial documentation is crucial because investors mostly ask for financial documents to evaluate the accurate financial position of the company and investment opportunities. Through financial documentation, they can quickly assess the profitability and liquidity; moreover, they can also get insight into the future plans and strategies of the company.

For example, an investor might use the income statement to identify the company’s profit rate.

Credit Assessment:

Banks and creditors use financial documents to analyze the trustworthiness and creditworthiness of the company. A bank can check a company’s balance sheet to evaluate the company’s assets and interest rates before approving a loan.

Preparation and responsibility:

Role of Management:

Management plays a significant role in the preparation of proper financial documentation. They are responsible for ensuring the company complies with standards like GAAP or IFRS and its strategic goals. Moreover, they must also gather all the details about the company’s revenue, expenses, etc.

Involvement of accountants and auditors:

Accountants are responsible for preparing the financial statements according to the accounting standards and rules. On the other hand, auditors are responsible for verifying the accuracy and reliability of the documentation. The internal auditors are responsible for checking the effectiveness of the company’s operations. The external auditors are independent and accountable for giving a fair opinion about the company’s compliance with standards.

Quality control and verification:

A company goes through many audits to verify the authenticity of its financial documents. Multiple audits help verify any errors or discrepancies before finalizing the documents.

 Approval process:

The company must also go through multiple layers to approve its financial documentation. Firstly, it’s approved by the company’s internal finance team and management.

The financial documentation is then approved by the board of directors or the audit committee, and then they are audited by external auditors; after getting approved by them, they are submitted to the regulatory bodies, and finally, they get released to the public.

Best practices and guidelines:

International standards:

Every company must follow international standards, e.g., “International Financial Standards (IFRS)“ or “Generally Accepted Accounting Principles (GAAP),“ while preparing financial statements to ensure the consistency and reliability of the company across different jurisdictions. Following a standard makes it easier for the stakeholders to understand the financial conditions of a company, even if they are foreigners.

Industry-specific considerations:

Every industry has different financial documentation requirements. So, every company must prepare its financial documentation accordingly.

Healthcare: some industries require detailed information about the company’s patient care costs, regulatory compliance, etc.

Technology: Some companies must provide detailed information about their research and development expenses.

Manufacturing: Some companies must provide detailed information about their cost accounting, inventory management (FIFO or LIFO), etc.

Transparency and disclosure Requirements:

The financial documentation should be transparent so that it builds a relationship of trust among the stakeholders. The statements shouldn’t be vague. They should be presented clearly so that the stakeholders can understand them easily. The documentation should be comprehensive enough to contain all the risks, predictions, and future planned strategies.

Documentation and record keeping:

After preparing and submitting the financial reports, the company should also keep a copy of them as proof for about seven years. This helps ensure that all the financial information is reliable, verifiable, and available for any audit.

Digital Age Implications:

Electronic filing and reporting:

As technology has revolutionized quickly, companies can now submit financial documents online to regulatory bodies. Electronic filing systems are more efficient, have many advantages, and can save time due to quick document processing. Moreover, it also reduces the chances of errors in documentation.

XBRL and Digital Formats:

 eXtensible Business Reporting Language (XBRL) is a global standard or digital format for digital reporting. XBRL makes the financial data readable to machines and easily comparable. It makes it easier for computers to extract and compare data from multiple companies instantly, saving time and error chances. Moreover, it allows for tagging individual data elements within financial statements, which helps in more efficient data analysis.

Real-time reporting:

With the technological revolution, companies can now share real-time reporting with regulatory bodies to give updated financial information. It helps avoid any lag about their actual financial events and reports. It helps management make informed decisions and attracts more investors.

Conclusion:

Individuals must clearly understand the difference between a financial statement and a financial report to make thoughtful decisions and effective communication. Financial statements provide the necessary factual and quantitative data, and financial reports provide the narrative and context behind them. With time, the reporting system has also been revolutionized, and companies can now submit their financial reports more efficiently.