Reviewing Vital Connections
Business managers and investors read financial reports because these reports provide information regarding how the business is doing. The top managers of a business, in reviewing the annual financial report before releasing it outside the business, should keep in mind that a financial report is designed to answer certain basic financial questions.
Statement of Changes in Owners’ Equity and Comprehensive Income
In many situations a business needs to prepare one additional financial statement – the statement of changes in owners’ equity. Owners’ equity consists of two fundamentally different sources – capital invested in the business by the owners, and profit earned by and retained in the business. The specific accounts maintained by the business for its total owners’ equity depend on the legal organization of the business entity. One of the main types of legal organization of business is the company, and its owners are shareholders because the company issues ownership shares representing portions of the business. So, the title statement of changes in shareholders’ equity is used for companies.
Making Sure that Disclosure Is Adequate
The primary financial statements (including the statement of changes in owners’ equity, if reported) are the backbone of a financial report. In fact, a financial report is not deserving of the name if the primary financial statements are not included. But, as mentioned earlier, there’s much more to a financial report than the financial statements. A financial report needs disclosures. Of course, the financial statements provide disclosure of the most important financial information about the business. The term disclosures, however, usually refers to additional information provided in a financial report. In a nutshell, a financial report has two basic parts: the primary financial statements and disclosures.
The chief officer of the business (usually the CEO of a publicly owned company, the president of a private corporation or the managing partner of a partnership) has the primary responsibility to make sure that the financial statements have been prepared according to prevailing accounting standards and that the financial report provides adequate disclosure.
Other disclosures in financial reports
The following discussion includes a fairly comprehensive list of the various types of disclosures found in annual financial reports of larger, publicly owned businesses – in addition to footnotes. A few caveats are in order. First, not every public company includes every one of the following items although the disclosures are fairly common. Second, the level of disclosure by private businesses – after you get beyond the financial statements and footnotes – is much less than in public companies. Third, tracking the actual disclosure practices of private businesses is difficult because their annual financial reports are circulated only to their owners and lenders. A private business may include any or all of the following disclosures but, by and large, it is not legally required to do so. The next section further explains the differences between private and public businesses regarding disclosure practices in their annual financial reports.
Keeping It Private versus Going Public
Compared with their big brothers and sisters, privately owned businesses provide very little additional disclosures in their annual financial reports. The primary financial statements and footnotes are pretty much all you get.
The annual financial reports of publicly owned corporations include all, or nearly all, of the disclosure items listed earlier. Somewhere in the range of 3,000 companies are publicly owned, and their shares are traded on the London Stock Exchange, NASDAQ or other stock exchanges. Publicly owned companies must file annual financial reports with the Stock Exchange, which is the agency that makes and enforces the rules for trading in securities and for the financial reporting requirements of publicly owned corporations.
You start reading the numbers when something strikes you: a zero cash balance? How can that be? Maybe your business has been having some cash flow problems and you’ve intended to increase your short-term borrowing and speed up collection of debtors to help the cash balance. But that plan doesn’t help you right now, with this particular financial report that you must send out to your business’s investors and your banker.