Financial Reporting for Growing Businesses

Financial reporting is a critical component of business, providing stakeholders with a window into the financial health and performance of an organization. From investors seeking opportunities to regulatory bodies ensuring compliance, financial reports serve as the bedrock of informed decision-making. In this article, we delve into the world of financial reporting, shedding light on its significance, key components, and how it empowers businesses to navigate the complexities of today’s economic landscape.

Although this article does not include a granular discussion of financial reporting techniques or systems, this will be reviewed in future articles. Read this article for a review of how to structure a finance team.

Note: Some distinguish the difference between financial reports—as reports designed to be shared with external stakeholders—and management reports—as reports used internally for operating decisions. The two will not be characterized separately in this article.

What are the objectives of financial reporting?

To determine what approach to financial reporting is best for a business, it is important to understand what the specific needs of that business are and how financial reporting can help fulfill those needs. Below, the main purposes of financial reporting are discussed along with some key considerations for each.

Decision Making: Budget Allocation and Financial Planning

For businesses of all sizes, making an effective financial plan requires countless assumptions, many of which are based on historical data and past operating experience. This is where an effective financial reporting framework plays a role—it aids more accurate budgets and financial forecasts (including cash forecasts, especially important for startups) by providing insights grounded in historical and real-time financial data.

For businesses, strong alignment between planning assumptions (inputs) and financial reporting outputs is vital. For example, a business may prefer to create and allocate the marketing budget using a decomposition of costs by marketing channel. In this case, it is important that historical data for marketing costs by channel are accessible for more sensible assumptions about the future.

And this extends beyond standard financial data found in the financial statements. For instance, if a SaaS startup best forecasts future monthly revenue as a function of segmented user count and ARPU, it is important that the company is accurately capturing and reporting segmented user count and ARPU. Although these types of metrics are often captured by the growth or product teams, the finance team may be involved with defining and verifying the data.

Decision Making: Capital Allocation

Capital allocation involves the distribution of finite resources. While budgeting can be considered a form of short-term resource allocation, capital allocation is more strategic in nature, focusing on the management of financial resources to achieve long-term goals, typically through rigorous analysis of major investment opportunities and growth initiatives.

Thus, a financial reporting strategy that accommodates this analysis is essential, providing the backbone of effective capital allocation decisions. After all, capital allocation involves assumptions about the future, assumptions that should be grounded in historical financial data, operating experience, and an understanding of broader market trends.

Regarding capital allocation, optionality and agility are extremely valuable as key assumptions are adjusted to reality. For example, launching a half-baked new product offering in a beta form is often an exercise in optionality (and a great way to learn from users). This approach allows the business to analyze initial responses to the new product with reduced investment before deciding whether to proceed with further investment.

Accordingly, as a business grows, it must adopt a financial reporting framework that supports a dynamic review of capital allocation decisions and the exercise of expected and unexpected options (e.g., accelerating investment in a new product line after early revenue and usage data suggest strong market alignment and extraordinarily high product margins). This leads us to the next topic, performance reporting, assessment, and accountability.

Performance Reporting, Assessment, and Accountability (Incentives)

The most obvious function of financial reporting is to analyze and understand the business’s performance. While developing and refining financial reporting capabilities, it is a good idea to be mindful of the questions that financial reports (and other metrics) must help answer. Working backward can then help to understand the implications for financial reporting and analysis. For example, some basic questions that need to be answered may include:

How profitable is the business and how is profitability trending throughout the year (on a monthly basis)?
Has the recent increase in customer support investment resulted in an adequate increase in retention?
At what rate are billings and revenues growing?
How much money was invested in working capital over the period?
What was the return on investment (ROI) of the manufacturing upgrade?

Because the nature of these questions shifts throughout the life of a business, businesses at different stages will have differing requirements and degrees of sophistication when it comes to financial reporting and analysis.

For example, a pre-revenue startup may keep track of monthly expenses on a cash basis in a spreadsheet or using simple bookkeeping software such as QuickBooks. For this startup, resources are extremely limited, and controlling cash outflows while launching a low-fidelity product is a priority—it makes sense to keep reporting as simple as reasonably possible.

Compare that to a startup that just surpassed $10 million in revenue and recently raised a series A. The investors are requiring audited GAAP financial statements on an annual basis and quarterly performance reports with monthly revenue and subscription metrics. Furthermore, the revamped board and leadership team will adopt a new monthly financial performance review framework. These conditions will dictate the minimal acceptable financial reporting requirements for the finance team, including levels of granularity and timeliness of reports.

Proper financial reporting also provides the basis for high-level performance reviews. For instance, department leaders are often assessed (and incentivized) based on how actual results compare to predetermined budgets and KPIs, while team bonuses may be tied to revenue goals and company profitability. Financial data must be captured and periodically and transparently presented in a manner that incentivizes team trust and success.

The level of complexity and the manner in which a business executes financially focused performance reviews and incentivization programs depends on several circumstances, including the size of the business, team experience, company culture, and the aggressiveness of the business’s long-term goals.

For example, for a technically adept finance team at a quickly growing startup that employs a young and ambitious team, the finance team may decide to create a near real-time variance analysis and financial KPI dashboard for the entire team to view. This would showcase progress towards goals in a gamified manner.

As a company grows and its operations and investment opportunities expand, its financial reporting capabilities must improve congruently to meet ad hoc financial requests and analysis as well as systemized investment assessment. Departments will increasingly request customized expense reports, vendor lists, etc. Simultaneously, the leadership team will become less involved with day-to-day operations and busier in reviewing strategic investment opportunities, resulting in a higher frequency of ad hoc financial data requests. These changing demands will require the finance team to implement new procedures and systems.

Investors and Creditors

Accurate, timely, and complete financial reports are central to existing and prospective investors’ understanding of a business’s performance while providing invaluable data to make inferences about the business’s future financial performance. For a company expecting to raise capital in the future, it is important to remember that strong financial reporting can be a large value generator.

This is because the development of professional reporting practices is foundational to building relationships of long-term trust with investors and creditors alike, ultimately leading to expanded networks and better capital accessibility.

Compliance

Effective financial reporting is also essential to ensuring a business remains compliant with legal and regulatory requirements. These requirements include:

Implementing suitable accounting standards (e.g., GAAP) – Compliance with common accounting standards ensures consistency, comparability, and accuracy of financial information. The finance team must be knowledgeable about these standards and how to apply them while reporting and analyzing data.
Meeting regulatory disclosure requirements – Depending on the type of business and stakeholders involved, there may be various financial and operating disclosures required by law. The finance team is often responsible for some of these.
Remaining tax compliant – In many cases, the finance team is also responsible for the business’s tax compliance, whether that be periodic sales or income tax filings.
Satisfying investor reporting requirements – Strong financial reporting is valuable to numerous stakeholders, especially those with financial interests in the business. Businesses often have contractual obligations to provide periodic financial reports to some of these stakeholders (e.g., investors, creditors).
Completing audits and keeping adequate internal controls – Audited financial reports may be required by tax authorities, financers, and others. The finance team must work closely with qualified auditors to ensure compliance with accounting standards while fulfilling data requests. Furthermore, the accounting and finance team must institute adequate internal controls to remain compliant with regulations and mitigate the risk of fraud.

Types of Reports and Analysis

The Basics

The standard financial reports that non-finance professionals will be most familiar with are the income statement, balance sheet, and cash flow statement. For those not familiar with any of these statements, a brief online review of each one is well worth it. There are countless YouTube videos and other resources explaining how each statement works.

The income statement, also called the profit and loss, is by far the most widely used of the three. This provides a breakdown of a business’s revenue, expenses, and resulting profits.

Because accounting is typically performed on an accrual basis, the cash flow statement is needed to present the change in cash over the period and is broken apart into three activities that may generate (or use up) cash: cash flow from operations, cash flow from investments, and cash flow from financing.

The balance sheet shows a business’s total assets, liabilities, and shareholder’s equity.

Very early in the life of a business, the most basic and important formal output of financial reporting is the profit and loss. At this point, it is not uncommon for this to be shown on a cash basis rather than an accrual basis.

As a business shifts to accounting on an accrual basis, a cash reconciliation is important to manage its cash runway. Some form of a cash flow statement is helpful for this analysis.

And as a business acquires (or develops) additional assets, invests or drains its working capital, and complicates its cap tables, a balance sheet becomes increasingly important.

Analysis – Common Size, Variance Analysis, Return on Investment, and More

Outside of the three financial statements mentioned above, financial reporting and analysis results in many other financial reports. Some of the most common of these include common size, variance, and return and investment analyses.

Common size analysis involves looking at financial statement line items as a percent of some base period value (horizontal common size) or as a percent of a correlated value from the same period (vertical common size). Common size analysis is a great way to find insightful trends from historical financial data.

Variance analysis shows a comparison of budgeted or forecasted values and actual values. This type of analysis shows how a business is performing relative to expectations and is frequently used for performance assessment.

Return on investment analysis includes various calculations and techniques used to assess the value generated from an investment in relation to the investment’s original cost to the business. As discussed previously, return on investment analysis is central to effective capital allocation.

Ad Hoc Requests

As businesses grow, there will be unique requests by key decision makers for customized financial reports and data. It is the job of the finance team to be reasonably responsive to such requests. Common ad hoc requests may include modified revenue and expense reports, receivables and payables reports, updated KPI reports, and much more.

Systems Used for Financial Reporting

Spreadsheets

At most businesses, most financial reporting and analysis happens within a spreadsheet (i.e., Microsoft Excel). This is especially true of ad hoc reporting, due to the flexibility and universality of working with financial data in spreadsheets. For those who expect to work closely with finance teams and related reports, becoming well acquainted with Microsoft Excel is well worth the time.

QuickBooks, FreshBooks, and Other Bookkeeping Software for Small Businesses

QuickBooks, the most prevalent bookkeeping software for small businesses, is one of the easiest and best ways for startups to account for transactions. There are countless resources for new users to learn how to use the software for proper bookkeeping as well as many professional bookkeeping services to help businesses on QuickBooks. FreshBooks is another popular choice for smaller businesses.

NetSuite, SAP, and other ERPs

As a business grows, QuickBooks and other accounting software for small businesses can become limiting. A more comprehensive enterprise resource planning (ERP) system can become valuable. ERPs integrate various business functions and databases (e.g., HR, procurement, accounting, billing) into a centralized platform for better reporting and analysis capabilities.

Although ERPs can be notoriously spendy with huge setup costs, many simpler solutions such as NetSuite by Oracle offer modularized pricing and relatively affordable entry points. SAP is one of the most popular ERP solutions for enterprises.

Regulatory Reporting Software

There are specialty software solutions that help businesses stay compliant with regulatory reporting and disclosure requirements. These solutions become especially useful for public companies that need to navigate an overabundance of red tape. Many of these systems are industry dependent.

Business Intelligence and Data Tools

As the finance function grows in sophistication, teams begin to rely on additional business intelligence and data analysis tools to amplify reporting competencies and visualizations. Power BI (a Microsoft solution with similarities to Excel) and Tableau are two tools that enable users to extract, transform, and visualize financial data from various sources, allowing for interactive and dynamic reporting. Enterprises may also use other solutions to develop complex multivariate models and algorithms for forecasting purposes.

Other Notes and Factors

Accounting Periods and Timelines

At a minimum, publishing annual financial statements is necessary. However, investors and boards also like to review statements on a quarterly basis, along with some accompanying financial commentary by the business’s management team. Reporting teams typically try to make these reports available to stakeholders within 60-90 days after the fiscal year ends and 30-45 days after the fiscal quarter ends.

For operating purposes, a monthly accounting period is most common among startups. Budgets, reports, and financial analysis are all performed monthly, with more detailed analysis and strategic discussions held on a quarterly and annual basis.

For ad hoc requests, the finance team should establish policies for communicating and responding to requests. As finance teams expand, ad hoc requests are often routed through a help desk platform, then prioritized and distributed to the appropriate finance team member(s). A lot of finance teams should aim to address the most urgent requests within 1-2 business hours.

Reporting Qualitative Characteristics

For those who have taken an accounting course, you may remember the discussion about the fundamental and enhancing qualitative characteristics of financial reporting. The two fundamental characteristics are relevance and faithful representation, while the four enhancing characteristics are comparability, verifiability, timeliness, and understandability.

These are all characteristics supportive of high-quality, decision-making useful financial data. They should be regularly considered by finance teams as they develop and execute a financial reporting strategy.

It is easy to see that without the two fundamental qualitative characteristics, relevance (providing information that is predictive and confirmatory; material) and faithful representation (data that is complete, neutral, and free from error), financial reporting becomes useless, or even harmful.

The four enhancing qualitative characteristics are less necessary for financial reporting but are integral to the usefulness of the reporting:

Comparability – Financial reporting should be performed in a manner that allows comparability with other entities and time periods; consistency of standards and formats plays a large role in comparability.
Verifiability – Financial data that can be verified by independent parties are considered to have verifiability; this provides confidence and trust amongst stakeholders that the financial reporting has been faithfully represented.
Timeliness – Financial information must be available in time to inform decisions, otherwise loses value significantly.
Understandability – The audience should be able to understand the financial information; concise reporting with clear footnotes and disclosures can improve understandability.

It is worth noting that some of these characteristics may at times counteract one another. For example, very timely data (e.g., real-time data) may naturally be data with limited faithful representation and verifiability.

The qualitative characteristics of reporting can always improve and should improve as a business matures.

Conclusion

In conclusion, financial reporting is a vital aspect of growing businesses as it provides stakeholders with crucial insights into the financial health and performance of an organization. It serves as a foundation for informed decision-making, aiding in budget allocation, financial planning, and capital allocation.

Financial reporting also plays a significant role in performance reporting, assessment, and accountability, enabling businesses to track their progress, assess their profitability, and align incentives for teams.

Additionally, accurate financial reports are essential for investors, creditors, and regulatory compliance. As businesses expand, they may face ad hoc requests for customized reports, necessitating the use of appropriate systems such as spreadsheets, bookkeeping software, ERPs, regulatory reporting software, and business intelligence tools.

By adhering to the qualitative characteristics of financial reporting, businesses can ensure the relevance, faithful representation, comparability, verifiability, timeliness, and understandability of their financial information, ultimately fostering trust and facilitating better decision-making.