Internal vs External Financial Reporting

What Is Internal vs External Financial Reporting?

Understanding the distinctions between internal and external financial reporting is important for any stakeholder.

Internal financial reporting is a routine practice in businesses where financial data is compiled regularly for internal use. These reports, holding confidential details like business indicators and financial performance, help the employees make well-informed decisions.

On the other hand, external financial reporting focuses on preparing information for parties outside the organization. Unlike internal reports, external reports exclude confidential details.

These reports are shared with potential investors, lenders, and creditors to assess the company's financial standing. Some of the key external financial reports include the income statement, balance sheet, and statement of cash flows.

Understanding Internal Financial Reporting

Data collection for internal usage, known as internal reporting, involves gathering and analyzing data primarily for internal team use. However, it can have various purposes beyond internal use, such as informing decision-making and strategy.

Instead, doing so to use it inside the team for various goals, depending on the report type:

• Enhancing marketing plan
• Redefining the KPIs
• Reducing expenditures, etc.

Internal reporting benefits both small and large enterprises, adapting to their specific needs and objectives rather than following a uniform format.

Different firms employ various reporting systems, such as centralized reporting with a designated person responsible or decentralized reporting with each team member providing regular updates to the boss.

Internal reports may contain confidential information, such as strategic plans, financial projections, or proprietary data, to assist management. Therefore, internal reporting is not intended to be shared with outside collaborators or the general public.

Types

Internal reports may be of the following types:

1. Routine Reports: These are also known as general reports or periodic reports. At regular periods, these sorts of reports are presented to management. The intervals might be weekly, biweekly, monthly, quarterly, half-annual, or yearly. Some reports are created and sent daily.
2. Special Reports: A report is created and delivered in response to management's request to achieve a specific goal such as a Special Report. Such a special report does not address the day-to-day issues. A special report is only provided after thoroughly studying any specific problem requiring special care.
3. Management Level Reports: There are three levels of management: top-level, medium-level, and lower-level. A report can't be beneficial to all levels of management at the same time. As a result, a report is written and filed according to the management level.

Uses of Internal Financial Reports

Uses of Internal Reporting include:

1. Gather information about the employees

Employee information can be obtained through internal financial reports. Internal employee reports may include information on employee performance, departmental operating efficiency, and issues relevant to organizational policies.

Management may use the reports to choose promotions, deployments, and layoffs.

If financial data indicate a decline in a department's productivity despite increased funding, management may use internal reports to assess the factors contributing to the decline and consider restructuring the department.

Management can also use employee reports to encourage whistleblowing, in which employees disclose acts that contravene corporate regulations. 

2. Keep track of client behavior and credit data

Internal reports, including financial reports, can be utilized to track the behavior of present clients, especially in businesses offering credit terms for sales transactions. It is effective in companies that provide credit terms for sales transactions. 

The report is used by management to assess how effectively credit customers adhere to their credit conditions.

For example, a retailer selling items on credit may demand that the credit department create a report detailing all credit customers, credit terms, credit amounts paid, credit amounts owed, recent defaults, etc. 

The information will aid management in distinguishing between credit customers who pay their bills on time and those who have missed or defaulted on their payments.

Management can then follow up with clients who have missed payments or determine whether to continue issuing credit or stop extending credit to them altogether. 

Understanding External Financial Reporting

External reports are designed to be shared with the general public and clients, investors, and other external partners.

Financial data is often the primary emphasis of external reporting, especially if a company needs to explain its expenditure to the customer and illustrate the return on investment of its operations.

If that's the case, it's crucial to filter the data in the report to ensure it doesn't contain any sensitive information that shouldn't be shared outside of the organization.

External reports are occasionally utilized for marketing objectives, such as providing a foundation for a case study or article written by a company's writer.

Companies may organize external reports in various ways, but a frequent practice is to identify the report's aim right at the start of the text because the audience reading it will be larger than that of internal reporting.

Types

External reports may be of the following types:

1. Reports to Shareholders: The shareholders, who are the true owners of the firm, are interested in learning about its success. As a result, yearly reports comprising a balance sheet, income statement, and directors' reports are created for shareholders.
2. Report to Government: The government receives income and sales tax information.
3. Report to Credit Institutions: Banks and financial organizations can provide a firm with credit. In this example, banks and financial organizations are interested in the company's financial situation. As a result, credit institutions are presented with financial performance and financial condition reports.
4. Report to Stock Exchange: Every company's stock is listed on a stock exchange. As a result, the stock exchange authorities must receive a report in the authorized format and a copy of the yearly accounts must also be given to them.

Uses of External Financial Reports

Uses of External Reporting include:

1. Provide financial information about a business

External financial reports are prepared for two key purposes. The primary purpose is to notify the general public about the company's financial condition. Public enterprises must report their financial performance statistics every year under the legislation.

2. Compare and contrast opposing entities

Because publicly listed firms rely on public funding, these companies are responsible for keeping the public informed about their financial health and activities. The public is curious about the profit or loss made throughout the year and the value of assets and liabilities, dividends paid, and so on. 

Financial analysts often use the data to generate ratios and assess the company's financial status.

Internal vs. External Financial Reporting

Now, let's understand the main difference between the two in the table below:

Researched and authored by Fatemah Kamali | LinkedIn

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