Why is accurate financial statements important

For example, comparing the fourth quarter of this year with the same quarter from last year will net a better result. Return on equity , or ROE, is a common profitability ratio used by many investors to calculate a company's ability to generate income from shareholders' equity or investments.

Companies issue shares of stock to raise capital and use the money to invest in the company. Shareholders' equity is the amount that would be returned to shareholders if a company's assets were liquidated, and all debts were paid off.

The higher the return or ROE, the better the company's performance since it generated more money per each dollar of investment in the company. Operating profit margin evaluates the efficiency of a company's core financial performance. Operating income is the revenue generated from a company's core business operations.

Although operating margin is the profit from core operations, it doesn't include expenses such as taxes and interest on debt. As a result, operating margin provides insight as to how well a company's management is running the company since it excludes any earnings due to ancillary or exogenous events. For example, a company might sell an asset or a division and generate revenue, which would inflate earnings.

Operating margin would exclude that sale. Ultimately, the operating profit is the portion of revenue that can be used to pay shareholders, creditors, and taxes. Liquidity ratios help shareholders determine how well a company handles its cash flow and short-term debts without needing to raise any extra capital from external sources, such as a debt offering.

The most commonly used liquidity ratio is the current ratio , which reflects current assets divided by liabilities, giving shareholders an idea of the company's efficiency in using short-term assets to cover short-term liabilities.

Short-term assets would include cash and accounts receivables , which is money owed to the company by customers. Conversely, current liabilities would include inventory and accounts payables , which are short-term debts owed by the company to suppliers. Higher current ratios are a good indication the company manages its short-term liabilities well and generates enough cash to run its operation smoothly.

The current ratio generally measures if a company can pay its debts within a month period. It can also be useful in providing shareholders with an idea of the ability a company possesses to generate cash when needed.

Debt includes borrowed funds from banks but also bonds issued by the company. Bonds are purchased by investors where companies receive the money from the bonds upfront. When the bonds come due—called the maturity date —the company must pay back the amount borrowed. If a company has too many bonds coming due in a specific period or time of the year, there may not be enough cash being generated to pay the investors.

In other words, it's important to know that a company can pay its interest due on their debt, but also it must be able to meet its bond maturity date obligations. The debt-to-equity ratio measures how much financial leverage a company has, which is calculated by dividing total liabilities by stockholders' equity.

A high debt-to-equity ratio indicates a company has vigorously funded its growth with debt. However, it's important to compare the debt-to-equity ratios of companies within the same industry.

Some industries are more debt-intensive since they need to buy equipment or expensive assets such as manufacturing companies. On the other hand, other industries might have little debt, such as software or marketing companies. The interest coverage ratio measures the ease with which a company handles interest on its outstanding debt.

A lower interest coverage ratio is an indication the company is heavily burdened by debt expenses. Efficiency ratios show how well companies manage assets and liabilities internally. They measure the short-term performance of a company and whether it can generate income using its assets. The inventory or asset turnover ratio reveals the number of times a company sells and replaces its inventory in a given period.

The results from this ratio should be used in comparison to industry averages. Low ratio values indicate low sales and excessive inventory, and therefore, overstocking. High ratio values commonly indicate strong sales and good inventory management.

Price ratios focus specifically on a company's stock price and its perceived value in the market. The dividend yield ratio shows the amount in dividends a company pays out yearly in relation to its share price. The dividend yield provides investors with the return on investment from dividends alone. Financial reports are usually prepared at the end of each quarter and fiscal year. These financial statements are used by management, stakeholders, investors, creditors, and debtors to gain insight into the financial status of your company.

They are the basis for making decisions on purchases, loans, and other activities related to the growth and operations of your business. There are five basic types of financial statements, the top three being the most important. Also referred to as the profit and loss statement, the income statement documents revenue and expenses for the company. It measures the performance of the business by listing all sales and expenses for the period. Management or business owners should compare their quarterly income statements for any big changes between them.

By keeping careful track of fluctuations and differences, you can look at ways to reduce expenses, if necessary. It is also known as the Statement of Financial Position because it provides information on assets, liabilities, and equities. Balance sheets are usually prepared at the end of the accounting fiscal year. It reflects a snapshot of the company at that particular point in time. Business owners and managers should compare each balance sheet with the last one for significant changes so that anomalies can be addressed.

For example, if inventory is growing faster than sales, you can investigate ways to more quickly convert it to sales. Accounting reports are statements that show the financial health of a business. Some reports show the results of a company's operations over time; others reveal a snapshot of a company's financial condition at a particular moment.

Common examples of accounting reports include balance sheets, profit and loss statements, statements of free cash flow, and statements of owner equity. There are also consolidated earnings statements for companies that have multiple departments or divisions , as well as more specialized reports, like accounts receivable aging.

But all of these reports have the same goal: to reflect the current financial state of a business. These accounting reports are prepared regularly by a company's senior management to guide company strategy and facilitate decision-making. Reports prepared according to generally accepted accounting standards can also be used to present to shareholders, lenders or insurers for various purposes.

These reports are not normally used in tax filings, but when used appropriately, they can certainly help small business owners understand their potential tax liability at any particular point in time. For most of use, when we think of accounting reports, we immediately think of taxes. And, sure, taxes are always a consideration when reviewing a company's financials.

But these reports are much more impactful and much more commonly used for other purposes. Most notably, these reports are used by management within a company to get insight into what's happening in the various segments of a business and make decisions about its operation — how to generate revenue and grow profits. For larger companies, accounting reports are also important for presenting the company's financial condition to shareholders, so they know what's happening within the company.

These reports provide key insights into the financial status of a company and the results of its recent operations. There are many different types of accounting reports that are used to reflect various aspects of a company's financial status.

However, there are four or five core types of accounting reports that are used by most small businesses. All of these are available from most small business accounting software packages:. Did You Know? In addition to these core reports, there are many others, and many more permutations of each, adjusted to meet the circumstances of individual businesses and the preferences of their owners and managers. Lots of executives create custom reports as well. These versions may focus on the areas of the business that management wants to track most closely, or compare recent results with those from the same time period last year.

The process of preparing an accounting report generally depends on the report, the size and scope of the business, the amount of detail you want to include in the report, and the time periods being compared.

Generally, the process involves totaling certain accounts for a set period of time. Modern accounting software can generate most accounting reports automatically, so the process for creating them varies only based on the accounting software you use.

Here are some popular reports and what they entail:. This process can be repeated for other reports you wish to generate. Accounting reports are predominantly used by a business's senior managers to assess financial situations and measure results. Even more importantly, the insights gleaned from various reports are used to make decisions about a company's general strategy. A balance sheet shows how liquid a company is — how much cash is available for investment in expanding business.

Reviewing these statements can help managers determine where and how to invest company resources to increase revenues, cut costs, and maximize revenue. Managers aren't the only ones looking at accounting reports. Here are a few examples of who else looks at financial statements and why:.