Updated July 20, 2023
What are Financial Reporting Objectives?
The objectives of financial reporting are to assess, understand, assimilate, and correctly decimate the income generated by the business. It helps the stakeholders formulate a correct stance and take up correct decisions about the management of the business.
Explanation of Financial Reporting Objectives
The Objectives of financial reporting are ascertaining and cross-verifying the usage of resources, business performance, and cash flow and assessing the business’s financial health. It ensures that all stakeholders are on the same page and undertakes better-informed decisions regarding managing investments in the business. The financial reporting objectives were formed keeping in view the capitalist markets frameworks.
During that period, the objectives asked the business to maintain an accurate and complete record of financial transactions with nil misses and no substantial information asymmetry. This was a mandate during that time to function in the efficient capital markets. The objectives were then later curated in the objectives as defined by the Financial accounting standards board. It ensured that the information asymmetry was removed completely. At the same time, the primary users of the financial reports, namely the investors and the creditors, got access to all the desired correct information.
Therefore, the financial reporting objectives ensure that the stakeholders provide correct and utility-based information to the end users of the financial reports, such as creditors and investors. On the basis of correct information, the lenders decide whether they should provide funds to the borrowers. The language in which financial reports are drafted helps the stakeholders understand what is happening in the business, and they don’t have to waste time understanding technical jargon.
The financing reporting also provides information on the entity’s cash flows and highlights potential cash flow problems or crises. The information is critical as pertaining to the liquidity of the business and helps the stakeholders to determine whether the business is going concern or not. Financial reporting mandates the business to disclose all trivial information about the economic resources and their obligations. It should emphasize the liabilities structure modifications and how resources are utilized, which in turn helps analysts predict cash flows.
Objectives of Financial Reporting
There are four broad objectives of financial reporting as follows:
It shares and decimates all the critical information to the potential investors, existing investors, customers, lenders, and creditors, respectively:
- The properly formulated and presented financial reporting helps the users of the financial statement assess whether a given business is profitable.
- For example, the investors and creditors assess the business’s income statement to ascertain the profitability delivered by the business. The income statement generally describes the profitability position of the business. If the business is not very profitable, it will not attract new potential investors, and existing investors will run away. The lenders won’t give additional funds to help the business run operations.
It helps in monitoring the position of cash flows for the business:
- A prudent financial report helps the stakeholders determine the actual cash flow position in the business. At times, the income statement is insufficient to ascertain the actual cash position. Hence, the users may wish to access the cash flow statement to analyze the position of cashflows.
- For example, suppose a business performs several financial transactions on an accrual and a non-cash basis. There could be a situation that the business does not have the cash flow positions claimed and shown as per the transactions. Therefore, to ascertain the figures on cash, the lenders and investors access the cashflows statements to ascertain the position of the business on the cash front.
It provides information on the adoption of accounting policies applied by the business to arrive at the accounting estimates:
- At times the business has access to different types of accounting policies. Based on their requirements and usage, it may select one accounting policy and implement them to determine the accounting estimates and financial numbers to create a formal financial report. The business, therefore, has to disclose the accounting policies front to the investors and the creditors. This allows the users of the financial statements to compare the financial statements of two companies operating in different or the same companies.
- For example, two companies could operate in the same industry but use different inventory valuation techniques. The first company has adopted the LIFO technique, and the second may apply the FIFO technique. Therefore, the business that applies the LIFO technique would report less income as it displays the high value of the cost of sales. On the other hand, the other company may have a high inventory and may overstate income levels. Hence, the business must disclose its accounting policies while preparing the financial reports.
It helps in the facilitation of meaningful analysis of the asset position, equity position, and liabilities position of the business:
- The users of the financial statements can note the current values of the asset position and liabilities position of the business. This would help the users of the financial statements predict what potential course of action a business may undertake soon.
- For example, A company is undertaking a huge investment project and would, therefore, like to ascertain whether the existing tangible assets can deliver on the project or whether it requires the business to purchase new equipment. The management can access already prepared financial reports and discover their needs and requirements here.
Conclusion
The objectives of financial reporting are to provide and decimate financial information from the business to the end stakeholders such as investors, venture capitalists, private equity, and banks. Financial reporting as an activity helps analyze, track, and monitor the financial information disclosed by the business. It allows investors and stakeholders to realize whether the business has properly utilized monetary and financial resources.
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