Financial reporting is a standard accounting practice of compiling financial statements to disclose to the public about a company’s financial information and performance over a specific period of time. This is usually performed on an annual or quarterly basis.
The four key financial statements used in financial reporting include income statements, balance sheets, cash flow statements and a statement of retained earnings.
In a nutshell, financial reporting is crucial to the survival of a company because it will tell key decision makers or business owners how much money they have, where the money is coming from and where the money needs to go.
It helps them make informed decisions so as to maintain the company’s financial health. This information is also useful for potential investors and banks on whether to invest or give a loan.
For financial reporting to be fully effective, accuracy, transparency and precision are the elements for success. For companies who do not have clear and solid internal financial controls and strict adherence to the accounting standards and rules, financial reporting errors can cause expensive losses in profits, growth and time.
So what are the dangers of inaccurate financial reporting in companies and their effects?
1. Increased Liability
Inaccurate financial reporting not only causes the company in question to make poor financial decisions but can also cause other companies to make the same mistakes.
Why? When errors in financial reporting present a company to be financially stronger than it is, other companies/ investors may decide to enter into a relationship with the company in question when they would not in usual circumstances. If the inaccuracy results in losses for other companies/ investors, they might file a civil suit to recoup their losses.
Financial reports not only go to key decision makers but also shareholders, government agencies and the general public. Errors in financial reporting can cause people to lose faith in the company’s credibility and reputation.
Even if the errors may be corrected quickly by the company’s accounting department, the fact that such errors can happen remains a big no no for some people. Loss of credibility and reputation can cause a drastic drop in company stock value and decrease in business prospects as potential affiliates will not want to associate with a company that has financial errors.
3. Waste Of Resources And Opportunity Cost
When there are errors in financial reporting, the key decision makers are unable to make informed decisions. It might cause them to make decisions that place a larger financial burden on company assets than what is wise. When there is a larger financial burden than intended, it causes a decrease in liquidity and in the midst of trying to sustain the company, certain assets might need to be sold off which can possibly catalyse the company’s closure.
Similarly, such inaccurate information may also cause them to miss potentially lucrative opportunities due to the impression of the company not being able to meet the requirements.
At times, the errors in financial reporting are not really errors. They are man made for the purpose of manipulating a particular situation. Eg. The key decision makers may issue inaccurate financial information to artificially deflate or inflate the value of stock, taking advantage of the chance to personally buy or sell stock. The parties involved may face criminal prosecution, resulting in fines or imprisonment.
In summary, it is vital to perform accurate financial reporting with honesty, transparency and accountability so the company can enjoy sustainability and success. The consequences of inaccurate financial reporting might prove too severe in some cases and difficult to remedy once they happen.