Internal vs external financial reporting have several key differences that you should be aware of. Internal financial reporting is a business practice that involves compiling financial information on a frequent basis for use within the organization. The documents may contain confidential information, such as business indicators, financial performance, performance indicators, etc.. They are designed to help those individuals working within the company to make informed decisions.
On the other hand, external reporting involves preparing financial information to be distributed to parties outside the organization. Unlike internal reports, external reports do not contain confidential information about the company.
The recipients of the external reports include potential investors, lenders, and creditors who require the reports to evaluate the financial position of the company. The main external financial reports include the income statement, balance sheet, and statement of cash flows.
Internal financial reporting involves compiling and analyzing financial information for use by management in decision-making.
External financial reporting involves compiling and reporting financial information for distribution among shareholders and potential investors.
Internal financial reports are designed to be viewed only by individuals within the organization, whereas external financial reports can be accessed by any person outside the organization.
Understanding Internal Financial Reporting
Financial reports prepared for internal use are different from the financial reports that are available to the public. Generally, internal financial reports tend to be more detailed in order to provide management with enough information to help in the decision-making process.
Since the internal financial reports are not available publicly, the company is not required to follow the Generally Accepted Accounting Principles (GAAP) when preparing the reports. For example, when preparing the sales report for the past six months, the management may require the accountant to include all transactions such as discounts, returns, and other line items that affect the net sales value. Generally, internal financial reports cover different subjects, such as sales, marketing, human resource, etc.
Uses of Internal Financial Reports
1. Gather employee information.
Internal financial reports may be used to provide information about employees. The management may require internal employee reports that provide information on employee performance, operational efficiency at the department level, whistleblowing activities, etc. The management may use the reports to make decisions on promotions, deployment, and layoffs.
When the financial reports show a decline in a specific department’s productivity despite receiving increased funding, the management may use the internal report to reorganize the department. Also, management can use the employee reports to encourage whistleblowing activities, where employees report activities that violate company policies.
2. Track customer behavior and credit information.
A company can also use an internal financial report to track current customers and monitor how credit customers are paying back credit. It works in businesses that offer credit terms for sale transactions. The management uses the report to see how well credit customers are honoring their credit terms.
For example, a retail company that sells goods on credit may require the credit department to prepare a report of all the credit customers, credit terms, the amount of credit already paid, the amount of unpaid credit, recent defaults, etc. The information will help the management to distinguish between the credit customers who are paying credit on time and the credit customers who have delayed or defaulted on credit payments.
The management may then follow up with customers who have defaulted on payments or decide whether to continue extending credit to the specific customers or discontinue further credit terms.
Understanding External Financial Reporting
External financial reporting is a business practice that involves providing financial information on a periodic basis to potential investors and shareholders. The reports are primarily financial statements and other related information about the company that investors require to make an investment decision. Usually, the reports do not contain confidential information about the company, unless it is disclosed to achieve a specific purpose.
Existing laws require public companies to publish a complete set of audited financial statements at the end of each financial year. It is done to meet the informational requirements of the different interested parties such as investors, analysts, regulators, etc. as well as discharge the accountability duty of the organization.
In the United States, publicly traded companies are required to submit Form 10-K annually and Form 10-Q every quarter to the Securities and Exchange Commission. The information is made publicly available to investors who require the latest financial information for a specific company listed in a public stock exchange.
Uses of External Financial Reports
1. Provide information about a company’s financial health.
There are two main reasons why external financial reports are prepared. The first reason is to provide the public with information about the financial health of the company. The law makes it mandatory for public companies to publish their financial performance information every year.
2. Compare competing entities.
Publicly traded companies obtain capital from the public, and, therefore, have a duty to keep the public aware of the financial health and operations of the company. The public is interested in knowing the profit made or loss incurred during the year, the value of assets and liabilities, dividends paid, etc. Financial analysts also use the information to calculate ratios and assess the company’s financial strength in comparison to other competing entities.
Thank you for reading CFI’s guide to Internal vs External Financial Reporting. To help you become a world-class financial analyst and advance your career to your fullest potential, these additional resources will be very helpful: