Financial reporting makes it easy to understand how your company is performing financially. CFOs can use this information to calculate the breakeven point, cash collections, and even debt financing. Financial reports are also required for taxes and accounting purposes.
Financial reports provide you with the critical information you need to track KPIs. The more often you generate and review your financial reports, the more accurate your KPIs will be. Below are the common reasons why financial reporting is important for your small business.
Managing taxes
The IRS uses various financial reports to ensure you’re paying the right amount in taxes. Accurate financial reporting can help decrease your tax burden by making sure you’re not overpaying and can mitigate the risk of error.
Attracting investors
Investors will want to see your financial reports to better understand your company’s financial condition before they decide to invest. Investors prefer companies that can generate higher profits and cash inflows each year.
Making decisions
Financial reports can help you make tough business decisions. With accessible financial data, you can make those decisions based on hard numbers rather than gut feelings or guesswork. This allows you to identify things like trends and roadblocks in real time, giving you the opportunity to either continue in a positive direction or to make changes as needed.
Maintaining compliance
Keeping accurate financial reports ensures that your small business is compliant with mandatory accounting regulations. Each financial reporting document you use is reviewed by multiple regulatory institutions, such as the IRS and the U.S. Securities and Exchange Commission (SEC), so it’s imperative that you keep accurate records to avoid penalties and further auditing.
Evaluating company health
Financial reports allow you to make business decisions using real financial data. This allows you to be completely objective when assessing the financial health of your company, but you can’t get the full picture without tracking that data against KPIs. KPIs allow you to keep tabs on your business’s financial performance. Here are three actionable KPIs you can use to measure your financial health:
Gross profit margin
Your gross profit margin shows you how much of your revenue is profit after you factor in expenses like the cost of production. The gross profit margin formula first subtracts cost of goods sold from revenue, then divides that number by revenue. The gross profit margin formula follows:
(Revenue – costs of goods sold) ÷ revenue = gross profit margin
Keep an eye on your gross profit margin. If your gross profit margin percentage begins to dip, you need to look for ways to lower your expenses.
Net profit
Your net profit is the amount of money you have after you’ve paid all your bills and expenses. Net profit is your bottom line. The net profit formula subtracts total expenses from total revenue. The net profit formula follows:
Total revenue – total expenses = net profit
In general, you’ll want to have net profit rather than net loss. Net profit means your business is making money. If your net profit begins to drop, you’ll want to investigate where your company is losing money, rather than making it.
Current ratio
Use the current ratio KPI to determine if you have enough money to fund a large purchase, like a new piece of machinery. The current ratio formula divides current assets by current liabilities. The current ratio formula follows:
Current assets ÷ current liabilities = current ratio
A current ratio of less than 100% is cause for concern. It means you may not have enough cash coming in to pay your bills. Tracking this KPI can alert you to incoming cash flow problems.