Financial reporting is a method of measuring a company’s performance by putting together organized statements that inform stakeholders of its financial history, projections and overall financial health.
In this post, you’ll learn about the main types of financial statements for startups, why they’re so important to master and more.
Table of Contents
- Why is financial reporting important?
- Benefits of financial reporting
- Key types of financial reports and statements
- Financial reporting tips
Why Is Financial Reporting Important?
In nearly every aspect of life, we use numbers and metrics to help us figure out how we’re performing. Sales teams track leads and conversions, content producers monitor page views and social audiences, and quarterbacks watch their touchdowns and interceptions.
As the quarterbacks of their companies, founders and CFOs need to make sure they’re keeping stakeholders informed of their financial operations.
Benefits of Financial Reporting
Financial reporting helps internal and external stakeholders stay updated on a company’s status so they can make informed decisions.
Think of the web of stakeholders you’re dealing with everyday: customers, employees, investors, banks and more. Each of these stakeholders is interested in different aspects of your financial status. Potential investors will want to analyze your numbers before making an investment. Your leadership team will want to understand the company’s financial position when planning out new hires for the year.
Everyone will be viewing the same information on your financial statements, but when you present financial analysis and reports, be sure to present the information in a way that’s most relevant to that specific stakeholder — like you would for a board of directors meeting or a leadership team call.
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Key Types of Financial Reports and Statements
Speaking of those statements, let’s take you back to Accounting 101. Every founder and CFO has to master three main financial reports:
The income statement reports financial results over a period of time, comparing revenue earned and expenses incurred.
It often tells stakeholders, “Here’s what we’ve earned and what we’ve spent growing the business over the past year.” Investors will be interested in revenue growth over time and how you’re spending capital. Trend analysis becomes particularly important in a startup, because often what you spend in a year is actually an investment for future earnings.
I always recommend that our clients track their income statement on an accrual basis, as opposed to a cash basis, if they plan on growing their business quickly (which they should!). An accrual basis provides a far more accurate view of the company’s health. Under that methodology, the income statement reflects revenue as it’s earned and expenses as they’re incurred, rather than when the cash trades hands.
For instance: If you pay in advance for a 12-month contracted service, the company would take that expense over 12-months, rather than a big one-time hit at the payment date.
The income statement is where to start the crucial process of financial modeling.
Rather than reporting financial position over a period of time, the balance sheet reports your company’s finances at a specific point in time. The income statement might read “for the year ending Dec. 31,” whereas the balance sheet shows a snapshot “on Dec. 31.”
The balance sheet shows your assets, liabilities and equity balances. It describes the resources your company has at its disposal and what it owes to others. Stakeholders will have an idea of your financial stability and if you have the resources to reach your growth projections.
Statement of Cash Flow
The statement of cash flow is a financial reporting document that communicates where your cash is coming from, where it’s going and the runway you have with your capital position.
Most startups are running lean balance sheets, so they need to know, quite simply, how much longer they have before they run out of money. A positive cash flow ensures you can make payroll, keep your platform running and know when you need to fundraise or seek out a startup loan for an injection of capital.
I recommend that early-stage companies utilize the direct method, which may be a simpler approach for less complex entities without complicated financing or investing cash flow activities. The direct approach lists cash inflows and outflows to form the statement.
If no stakeholders require a formal statement of cash flow, you could consider reporting an informal cash movement analysis, which can provide a simpler approach to cash burn and runway calculations, to support decision making.
Financial Reporting Tips
Understanding the three main financial statements is a great starting point. Here are three more quick tips to bolster your financial reporting strategy:
Take Time for Financial Modeling and Forecasting
You wouldn’t go on a road trip without a map or GPS, right? The same goes for your startup growth. Building and updating a sound financial model will help you plan for the future and communicate your growth goals to stakeholders.
Be Wary of Your Burn Rate
How long will your cash last? It’s a vital question for most startup founders and CFOs.
Gross burn rate shows how much cash is spent each period compared to your available capital. Net burn rate considers cash spent only in excess of cash received, which provides a more accurate picture of cash runway for companies that generate steady revenue, such as platform companies with subscription models.
Your cash runway indicates how long the company can operate at the current or projected burn rate before it runs out of resources. Be sure to source additional funding, whether equity or debt, while you have several months left on your cash runway to allow time to work through the process.
Analyze Ratios and Trends
Ratio and trend analyses are necessary for time-strapped founders who can’t always manage every finance down to the penny. Keep accurate data so that you can analyze ratios and financial trends to help you understand your company’s health now and over time.
Diligent financial reporting helps you analyze trends in the present and plan for the future.