What Does Reporting Mean?

Strategizing the finance function involves conceptualizing and designing infrastructure that will suit the organization’s data needs now and in the future. Although this is no easy task, the strategizing effort eventually must focus on higher-level, soft components to ensure development of a relevant finance function. This means addressing upper-tier considerations of the multilevel approach to strategizing. Developing the reporting aspect of the finance function is the key summary objective of upper-tier considerations for the small and emerging business owner. Reporting in this context refers to (1) the capacity to translate data into formal or informal presentation formats and (2) identifying and developing analysis paradigms, growth models, and metrics to aid in decision support. Conceptualizing these two major aspects of reporting is critical to the design of the finance function, particularly infrastructure. Eventually, the small and emerging business owner will need to develop certain balance sheet and P&L strategies that support the reporting effort. The capacity to develop these aspects of the finance function will dictate success in internal and external reporting efforts. Laying the foundation early and developing the capability to generate meaningful reports will make for a strong finance function that will lead the business forward and allow for adjustments and change when necessary.
The urgent demands of the day-to-day operations in the early, precarious stages of business development may occupy the attention of the small and emerging business owner. Notwithstanding, there will always be a need for reporting, whether it is formal financial statements or esoteric analysis models. What’s involved with producing financial statements? How suited is the business and its finance function to producing them? What are the key dependencies? How will the finance function keep up with internal and external reporting needs? The first step is to understand the need for reporting.

Purpose of Financial Reporting

One of the biggest challenges the small and emerging business owner will encounter involves understanding how the company is performing. The most accurate depiction the company will convey comes through the financial data it generates. It is the challenge of management/owners to report this data effectively, which includes translating it into intelligible financial statement form.
Reporting, as it relates to the finance function, represents the actions or exercises that transmit data harnessed by the data flow process to data customers. These actions include creating reports, presentations, or other platforms of data delivery. Reporting in the enterprise focuses on identifying and assessing data in the business environment as it relates to the organization’s objectives to key decision makers. Key decision makers in this case would be the small and emerging business owners/managers. Financial reporting helps owners make decisions regarding their investment in the organization or aids creditors in assessing whether to lend funds to the business. Reporting also provides owners and other stakeholders information on the use of or need for the most important resource in the business— cash. Financial data, whether it comes as formal financial statements or customized evaluation metrics, provides knowledge on the utilization of resources. Whether it deals with people, equipment, dollars, or intangibles, financial reporting provides the ability to measure resources used to run the business and provide direction for future needs.

The small and emerging business owner will find that financial reporting shapes the company’s relationship with the business environment. It may seem that financial reporting is merely the depiction of the business environment and how the company exists in it. In fact, this “one-way” relationship is a misnomer, in that reporting dictates decisions that relate to resources within the company and the allocation of resources outside. This is especially true with financial data disclosed in the public sector. Financial reporting also provides an indication of performance relative to a business’s peer group. Is the business doing better than others? Worse? If performance is above or below industry peers, do owners/managers know why and in what ways? Financial reporting plays a role in the decision-making dynamic by providing a view of relative performance and the use of and need for resources. The examination of formal reporting tools will lead the small and emerging business owner to consider financial statement tools that will suit current and prospective decision needs. Generally, the need will exist for two types of financial statements: those that illustrate company performance over a period of time and those that measure the state of the company at a point in time.

Most Frequently Used Financial Statements

Measuring performance over a period of time will give owners and other stakeholders the ability to see how well the company’s use of resources yields products and services. Profit and loss statements are used to show how expenditures yield income over a period of time—monthly, quarterly, or yearly. Overall, this statement will provide information on the availability of cash, particularly the amount and timing. The P&L is inherently based on historic information, which is not necessarily indicative of future performance but offers valuable insight into trends and patterns in the external environment and inside the company.

Key to the usefulness of P&L statements is in the detail or components of income. Understanding these components provides practical insight into the historical performance of the company and its likelihood for future success. For example, two companies with similar bottom lines may be distinguished by the fact that one company achieved this number through solid margins and practical expense levels, while the other achieved the number via an extraordinary event (e.g., asset disposal, insurance proceeds). It is not practical to base a business model on unpredictable windfalls. Good financial reporting provides an indication not only of the amount and timing of cash flow but of the risk of attaining certain cash flow expectations.

A balance sheet provides an assessment of the company’s financial state at a given point in time. In particular, it provides information on the details of company resources, company obligations, and the interests of owners. The balance sheet provides an evaluation of company resources available in the future as well as commitments the company has made to outsiders. This type of financial statement provides an understanding of the value of the stake each owner has in the enterprise by illustrating the value of equipment, inventory, and intangibles as well as commitments and contingencies to outsiders.

The balance sheet serves to augment the information presented in the P&L and provide information on the availability, timing, and risk of future cash flow. The balance sheet presentation of inventory, accounts receivable, and accounts payable provides an indication of future cash flow and the anticipation of revenue. Analyzing the balance sheet over time is particularly useful as the ebb and flow of balances can be understood and translated into useful business decisions. Unique to the balance sheet is the assessment of capital structure and its impact on liquidity. Key stakeholders such as creditors and equity owners have an interest in the relative level of liabilities (both long and short term) to assets. Can the company meet its debt obligations from period to period? Will the company be able to pay out its dividend? The balance sheet is an honest depiction of the organization for both internal and external stakeholders.

The statement of cash flows combines P&L and balance sheet components to provide information on how the company utilized its most important resource over a specified period of time—cash. A formal cash flow statement will distinguish cash flow from operations, investing activities, and financing activities. If a company is publicly traded, it must prepare a formal cash flow statement in accordance with GAAP. Although the complexities of preparing a cash flow statement will not be addressed here, it is worth noting that small and emerging business owners must understand the uses or sources of cash, especially in the early stages of business development. They must motivate and base incentives for current and future employees on P&L items (e.g., revenue, margins) as well as the amount of cash generated or collected. Becoming familiar with this financial statement will aid small and emerging business owners with the decision-making process and ensure that managers/owners are in sync with business needs.

Certain aspects of financial statements may be mixed to help analyze the business. Creating ratios with balance sheet and P&L components will help the small and emerging business owner make decisions about customers and products. For example, Days Sales Outstanding ratios—made up of accounts receivable (balance sheet) and revenue (P&L)—help evaluate the quality of customers or the organization’s efforts in servicing receivables. Inventory Turns ratios, made up of cost of goods sold (P&L) and inventory (balance sheet), help provide an understanding of the supply chain and how well inventory is being managed.

Understanding how these standard financial statements work and their value to decision makers is key, as most analysis and reporting is based on information derived from them. The strategist must have a clear understanding of the need for these basic financial statements and the level of detail that will be necessary to make them useful.

Standard versus Nonstandard Reporting

In many contexts, the term reporting refers exclusively to preparing formal financial statements. Preparing them for external and internal purposes depends, for the most part, on the ability of the finance function to produce financial information in a prescribed format. Some companies, however, will have requirements to relay peripheral financial information to data customers outside the organization. These nonstandard reporting requirements may have the same weight as formal, standard reporting requirements and/or a heavy consequence for noncompliance. Attention to nonstandard reporting requirements will be a particular priority for publicly traded companies. What are these reporting requirements? How should they be addressed? How do they impact the finance function and strategy?
Nonstandard reporting requirements may come about as a result of legal obligation, regulatory requirement, industry practice, or voluntary management disclosure. This type of reporting is unique in many ways to publicly traded companies, although privately held companies also may engage in nonstandard reporting. Examples of nonstandard reporting include:

- Press releases (quarterly earnings or otherwise)

- Reporting to the U.S. Census Bureau

- Responses to or reporting for tax audits (state and federal)

- Filing the Form 8K, Current Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

- Management Discussion and Analysis (MD&A) in corporate annual reports and Form 10K, Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

- Filing prospectuses and offering investment circulars

What makes this reporting different from standard reporting requirements? The circumstances that give rise to it and/or the motivation for a desired end distinguish this type of reporting from that of standard reporting—producing balance sheet, P&L, and cash flow statements. The following factors distinguish nonstandard reporting from standard reporting requirements:

- Irregular timing. Requests for data/reports by governmental agencies will have timing constraints that go beyond the standard timing for data requirements in the organization. Where standard reporting comes in annual, semiannual, quarterly, or calendar-month increments, tax notices may have response time increments anywhere from 10 to 90 days from the date of the notice. For public companies, a Form 8K filing is required (per the SEC) to disclose a significant event within a reasonable time period after the event occurs. The finance function must be prepared to manage planned reporting requirements and be able to respond quickly and intelligibly in nonstandard time frames.

- Urgency. Although some nonstandard reporting is done in anticipation of a significant, desired business life cycle event, most is done in response to an authoritative request for information. Inaction may have consequences for the business. This type of reactive reporting must be accurate and timely.

Initial responses to notices for tax audits, whether at the federal, state, or local level, may not require financial information per se, but simply an acknowledgment of receipt of the notice. The brevity of that response may induce a positive, qualitative evaluation by authorities regarding the organization and lessen the blow of an examination or lien. The finance function must be suited to respond to various requests.

- Compulsory responses. Most nonstandard reporting is not optional. Regulatory authorities, governmental bodies, or the general public may issue demands for information to which the business must comply. The right to do business, access to public funds, or market capitalization may be at stake if an organization is reticent regarding a nonstandard data request.

Addressing nonstandard reporting requirements will require the ability to respond in a timely manner with accurate and relevant data. This sounds simple, but because this reporting is either nonrecurring or unorthodox in nature, it is not unusual for these requests to get lost or misinterpreted, or simply be ignored. For example, notices of tax audits usually come in writing, with a time-sensitive response required. Actions are dictated by the passage of time and the response or lack thereof of the target company. What is in place to ensure that written notices are delivered to the proper personnel and interpreted properly? Small and emerging businesses are susceptible to these communication breakdowns as divisions of duties and definition of roles sometimes are vague or unclear.

The finance function must be able to handle nonstandard reporting requirements. Establishing a full-time owner of finance and accounting may be the most important step in handling these types of issues. Creating an environment/culture of awareness in matters of finance also is crucial in handling nonstandard reporting requirements, especially in a small organization where few people handle many different responsibilities. The strategist, as it relates to the multilevel approach, must review the business life cycle and understand the potential for nonstandard reporting requirements before they are encountered. Realizing which stages of growth or life-cycle events expose the business to these requirements will allow for provisions to be made and an awareness to be established.

Internal versus External Reporting

Just as the company will change and evolve, so too will its reporting needs. The small and emerging business owner must be aware of these shifting reporting needs and have the capacity to accommodate them. One of the most important distinctions that must be made when it comes to addressing reporting needs is that of internal versus external reporting needs. The finance function must be equally suited for both. How will the stages of the business dictate the nature of reporting? What demands will these two types of reporting put on the finance function?

Reporting that focuses on internal analysis needs and drives day-to-day decision making is called internal or management reporting. The majority of these reporting needs will be internal, revolving around analysis for in-house decision making, in the early stages of the company’s life cycle. The overall objective of internal reporting is to provide the information necessary to ensure that resources are maximized and strategic decision making is reliable. The complexion of management reporting will change as the company evolves. Measuring, understanding, and applying new metrics to help make strategic decisions for the company in a dynamic environment lie at the core of management reporting needs. Reviewing operating expenses or revenue run rates in the early years may evolve into analyzing receivables days-sales-outstanding and inventory turns or cash flow versus revenue trends. The design as well as the detail of financial data reported will improve or shift with the company’s changing needs. Internal reporting needs may focus on standard reports and financial statements (balance sheet, P&L, and cash flow statement) or on more customized analysis and evaluation tools. The finance function must be synchronized with the needs of internal data customers to be certain that internal reporting needs are being met.

The organization, if it is not already, may be charged with statutory reporting requirements as it matures. These filings are an example of external reporting requirements. These reporting requirements often are detailed in their content and timing of release. Public filings and disclosures with governmental authorities are good examples of external reporting requirements. They may be an integral part of the company’s growth cycle. Financial statements generated for these purposes must follow a certain format with certain time frames for filing. Many small and emerging businesses fall in the trap of relying on financial statements prepared for external purposes to suit internal reporting needs. Although these financial statements may seem to provide enough information to run the business in the short term, the need for granularity and specificity in reporting will eclipse the value these rigid statements provide to decision making. Over time these financial statements will have limited value-added impact for the organization. Filing these timely and accurately will keep the company in compliance with legal or contractual obligations and nothing more. It is worthwhile to focus on developing the processes that create these statements, with the object being to minimize manual input and time. These financial statements, especially in the early stages of company development, may be the only regularly produced reporting instruments. Burgeoning companies are best served to shape their internal reporting needs from these financial statements and use the processes for developing them to hone their internal reporting routines.

Unlike internal financial statements, the production of external financial statements must become a process-driven exercise. Internal financial statements will be shaped by the demand of internal data customers, refined and reevaluated regularly, and should be a continual focus of the finance function. The finance function must ensure that external financial statements are prepared accurately and in a timely manner; the goal is to spend as few resources on generating them as possible. Automating the preparation of Form 10Q, Form 10K, audited financial statements, tax returns, and government census reports should be the aim from the outset, as the company gains little value-added benefit from generating them.

Key Dependencies

Many entrepreneurs and executives find that maintaining the financial reporting aspect of the business is a burdensome distraction to operations. The ability to translate the business into relevant financial reporting tools, whether they are for internal or external purposes, goes hand-in-hand with doing business. Whether it is fulfilling the data needs of owner/managers or complying with an external/statutory reporting requirement, the finance function must be prepared to generate accurate and timely financial information. Key areas or dependencies that will dictate the quality of reporting are:

- Sophistication of management. Not only will management/owners be charged with interpreting the data that results from the reporting process, but they also will make decisions regarding the processes and resources that yield the reporting. Management must have an understanding of the business that goes beyond operations. Operational decisions cannot be made if good information cannot be harnessed and passed on to management. The finance function must be carefully strategized, funded, and maintained to ensure that the information ecosystem stays intact at all times.

- Appropriate accounting methodologies. Do accounting methodologies translate the company accurately to financial statement form? Is the revenue number reliable? How about cost of sales and operating expenses? Reports and financial statements will be of no value to the organization if the information presented is unreliable. The finance strategist must ensure that the accounting methodologies are employed correctly before allowing the organization to rely on reports, metrics, or automatically generated data models.

- Changing business. Businesses are always changing, and reports that were relevant in the past may not be appropriate in the future. The finance strategist must understand this and be poised to identify aspects of reporting that will always be needed (e.g., balance sheet, P&L, cash flow statement) and those that will change with the business (e.g., ratios, turnover, operating leverage, financial leverage).

To achieve success, small and emerging business owners must master financial reporting early on. Whether it is internal, external, formal, informal, standard, or nonstandard reporting, the business has a vested interest in ensuring the finance function is suited to meet all reporting needs. Although different companies may interpret the upper tiers of the multilevel approach to strategizing differently, the small and emerging business owner is best served by focusing on the capacity to create financial reports. Considerations related to optimizing balance sheet and P&Lpresentation are one and the same with reporting at the early stage of the business life cycle. The finance strategist must next understand and incorporate accounting methodologies into the finance function.