Good financial statements empower your company to make better strategic decisions, but how do you know if your financial statements are good? If they're not, how do you make them better? Some basic principles separate the good from the bad, but your financial statement quality also depends on how well suited it is to your audience.
This blog is the second of a three-part series on how to create better financial statements:
Part 1:6 Elements of a Good Financial Design Statement
Part 2: Formatting Best Practices for Financial Statements
Part 3: Data Visualizations for Financial Statements
What makes a financial statement useful?
FASB (Financial Accounting Standards Board) lists six qualitative characteristics that determine the quality of financial information: Relevance, Faithful Representation, Comparability, Verifiability, Timeliness, and Understandability.
Relevance
Information is relevant if it is capable of affecting users' decisions, either because it helps them predict future business conditions or because it provides feedback on prior predictions. Irrelevant information takes up valuable report space and may confuse users.
Faithful Representation
To faithfully represent information, it must be complete, unbiased, and error-free. Perfectly faithful representation is rarely possible but try to get as close as you can.
Comparability
Information is more useful when it can be compared with similar information about another entity or with similar information about the same entity from a different time period. Being consistent about how you format your reports and what information you include will help with their comparability.
Verifiability
Information is verifiable if different knowledgeable and independent observers could reach a consensus that the information is faithfully represented. Verifiability gives users confidence about the accuracy, completeness, and neutrality of the information.
Timeliness
Information needs to be available to decision-makers in time to be capable of influencing their decisions. Older information can still be timely if it allows users to identify and assess trends.
Understandability
Information should be clear and concise and fit the audience's knowledge level.
Sometimes it is not possible to meet all of the above criteria at once. For example, you may spend so much time ensuring that the information on a report is complete that it ceases to be timely. Good report writing requires you to find an acceptable balance between conflicting goals.
Matching your reports to your audience
There are two main types of reports: financial reports and management reports. Which one you choose depends on your audience.
Financial reporting
Financial reports are aimed at external users who need to make decisions regarding your company, such as whether to invest or to extend a line of credit. They are more formal in structure and content because they must follow GAAP rules. Since all companies follow the same structure and content rules, it is easier for users to compare two companies' reports.
Management reporting
Management reports are aimed at internal users who need to make decisions on the company's behalf. Since these reports are not seen by outsiders, you can provide more in-depth information without giving away proprietary information. You do not need to follow the strict structure and content rules that apply to financial reports, but you should still ensure your reports meet the FASB qualitative characteristics. While you have more freedom when creating management reports, you also have to make more decisions and therefore have more room for error.
How ActivReporter makes your reports better
ActivReporter'sdrilldown feature allows authorized users to obtain detailed information about the individual transactions that make up the big picture numbers, while published reports provide the necessary information to external users without giving away non-public information.
Report templates allow you to quickly create consistent, up-to-date financial reports, while the native excel features make it easier to create any management report imaginable. ActivReporter'ssecurity permissions allow you to tightly control which members of your organization can see which pieces of information.
During our series on how to create better financial statements we've shared some best practices for formatting both types of reports, looked at various data visualizations, and in this blog, discussed FASB's qualitative characteristics of useful financial information, and the differences in purpose between financial and management reporting. Now you should be ready to present your financial designs to your team!
FAQs
The major elements of the financial statements (i.e., assets, liabilities, fund balance/net assets, revenues, expenditures, and expenses) are discussed below, including the proper accounting treatments and disclosure requirements.
What are the 6 financial statements? ›
The usual order of financial statements is as follows:
- Income statement.
- Cash flow statement.
- Statement of changes in equity.
- Balance sheet.
- Note to financial statements.
FASB (Financial Accounting Standards Board) lists six qualitative characteristics that determine the quality of financial information: Relevance, Faithful Representation, Comparability, Verifiability, Timeliness, and Understandability.
What are the main elements of the financial statement? ›
There are five elements of a financial statement: Assets, Liabilities, Equity, Income, and Expenses.
Which of the following are the six parts of the financial system? ›
It breaks down the financial system into its six elements: lenders & borrowers, financial intermediaries, financial instruments, financial markets, money creation and price discovery.
What are the basic financial statements? ›
For-profit businesses use four primary types of financial statement: the balance sheet, the income statement, the statement of cash flow, and the statement of retained earnings. Read on to explore each one and the information it conveys.
What are the characteristics of an ideal financial statement? ›
Qualitative Characteristics of Financial Statements
Qualitative characteristics are the attributes that make the information provided in financial statements useful to users. The four principal qualitative characteristics are understandability, relevance, reliability and comparability.
Who are the six users of financial statements? ›
The users of financial statements include present and potential investors, employees, lenders, suppliers and other trade creditors, customers, governments and their agencies and the public.
What are the 4 key financial statements? ›
There are four primary types of financial statements:
- Balance sheets.
- Income statements.
- Cash flow statements.
- Statements of shareholders' equity.
The chapter explains the fundamental qualitative characteristics (relevance and faithful representation) and the enhancing qualitative characteristics (comparability, verifiability, timeliness, and understandability) of useful financial information and notes the cost constraint.
In addition to the aforementioned characteristics (i.e., relevance, reliability, comparability, and consistency), the following qualities of accounting information affect its usefulness: understandability, materiality, and conservatism.
What are the main objectives of financial statements? ›
The main objective of preparing the financial statement is to present a true and fair view of the financial performance and position. Accounting data is summarised in such a way that the profitability of the business is clearly visible. It also serves as an information tool for all the parties concerned with the firm.
What are the six components of financial statements? ›
The components of Financial Statements are the building blocks that together form the Financial Statements and help understand the business's financial health. And consists of an Income Statement, Balance Sheet, Cash Flow Statement, and Shareholders' Equity Statement.
What do the essential parts of the financial statements include? ›
What are the elements of financial statements?
- Balance sheet. The balance sheet shows what the company owns and how much it owes at the end of the period. ...
- Income statement. An income statement shows the profitability of your business. ...
- Cash flow statement. ...
- Statement of retained earnings. ...
- Notes to the financial statements.
What are the Golden Rules of Accounting? 1) Debit what comes in - credit what goes out. 2) Credit the giver and Debit the Receiver. 3) Credit all income and debit all expenses.
What are the primary financial statements list and define them? ›
The three main types of financial statements are the balance sheet, the income statement, and the cash flow statement. These three statements together show the assets and liabilities of a business, revenues, and costs, as well as its cash flows from operating, investing, and financing activities.
What financial statement elements relating to income are defined in FASB Concepts statement 6 as follows? ›
Those elements are: assets, liabilities, equity, investments by owners, distributions to owners, comprehensive income, revenues, expenses, gains, losses. The elements of financial statements are the building blocks from which financial statements are constructed.
What are the four primary financial statements? ›
There are four primary types of financial statements:
- Balance sheets.
- Income statements.
- Cash flow statements.
- Statements of shareholders' equity.
The three basic elements of a financial accounting system are: Rules for determining what, when, and how much should be recorded. A framework for preparing financial statements. Controls to check for potential errors in the recording process.
