HOW A FINANCIAL
REPORT IS BUILT

Financial reports are a key cornerstone of investment analysis, yet few investors understand how these comprehensive documents come together. Understanding how companies build these reports provides crucial context for evaluating the information they contain.

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Behind every financial report lies a meticulous construction process that transforms raw company data into structured narratives, helping to shape investment decisions.

The process follows rules set out by regulators and guidelines based on a company’s desire to be transparent to investors. While formats and reporting protocols vary depending on jurisdiction, the build process and core components are broadly similar. From initial data collection through to final regulatory submission – this is what you need to know about how financial reports are constructed.

Understanding How a Financial Report is Built

The construction of an annual financial report begins months before its publication date. Companies typically start gathering data 90-120 days before their fiscal year-end, initiating a complex process that involves multiple departments working in concert.

The finance team coordinates with operations, legal, compliance, and executive management to ensure every piece of information meets regulatory standards and accurately reflects the company’s position.

At its core, the process is expected to follow a structured timeline. Initial data collection begins with closing the books, followed by preliminary analysis and drafting.

Companies typically adhere to Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS). However, some countries may have their own national accounting standards. These standardised frameworks ensure consistency and comparability across different companies.

Construction timeline

The construction timeline typically unfolds in distinct phases. The length of each stage can vary based on the size of the company, the complexity of its operations, and the jurisdiction’s specific regulations. A typical timeline might be as follows:

Weeks 1-4: Data aggregation

Weeks 5-8: Initial drafting and internal review

Weeks 9-12: External audit procedures

Weeks 13-16: Final compilation and filing

Throughout this process, companies must balance transparency requirements with competitive considerations, ensuring they meet their legal and regulatory disclosure requirements, while protecting commercially sensitive information.

Management Discussion & Analysis (MD&A)

The MD&A section represents the company’s opportunity to tell its story beyond the numbers. This narrative component requires careful construction, as it must provide meaningful insights while remaining compliant with regulatory guidelines.

The MD&A section is typically based on interviews with executives and conclusions drawn at strategic planning sessions. It is an opportunity for a firm’s leadership team to articulate their perspective on performance, market conditions, and the future outlook for the company’s business model.

Building the MD&A involves multiple drafts and iterations, often involving specialist financial writers experienced in translating complex operational data into clear, accessible prose.

The initial version typically comes from the CFO’s office who incorporates input from department heads about operational performance. Legal teams then review for compliance, ensuring forward-looking statements include appropriate safe harbour provisions. The narrative must strike a delicate balance: providing substantive analysis without making unsubstantiated claims or revealing competitively sensitive information.

There is some degree of flexibility regarding what information is included in the MD&A section. It might expand on year-over-year comparisons, insights into firm-specific or sector-related trends, and offer explanations of significant developments over the past year, and plans for future development.

Risk Factors

Constructing the risk factors section requires systematic identification and documentation of potential challenges facing the business. This process typically begins with enterprise risk management teams conducting comprehensive assessments across all business units.

That team gathers input through interviews, workshops, and risk registers maintained throughout the year. The documentation stage involves categorising risks by type which include:

• Operational risk
• Financial risk
• Regulatory risk
• Reputational risk
• Strategic risk

Each identified risk undergoes evaluation for materiality and likelihood, with only the most significant making it into the final report. To aid the process, companies often maintain a risk matrix that tracks emerging threats and evolving challenges throughout the year. This living document feeds into the annual report construction process, ensuring the risk factors section reflects current realities rather than outdated concerns.

Legal teams play a crucial role in report construction and risk factors are carefully worded. There is a need to ensure risk descriptions are sufficiently detailed to meet disclosure requirements, convey genuine risks, and avoid litigation exposure, while at the same time avoiding unnecessary alarm or providing competitors with strategic insights.

Given the amount of time invested in creating this section of the financial report it is not uncommon for the wording of risk factors to be relatively consistent over time, from quarter-to-quarter or year-to-year. That means that even minor changes to phraseology could provide clues to there being a larger shift in underlying dynamics and merit further analysis.

Financial Statements

The financial statements represent the quantitative heart of any financial report. The three most important financial reports being the balance sheet, income statement, and cash flow statement.

The construction of the financial statements is carried out by a firm’s accounting department and continues throughout the fiscal year. This helps to ensure that they record transactions and maintain accurate records to comply with established accounting principles.

Financial statements are all based on standardised accounting principles that ensure consistency and comparability. Depending on the domicile of the company, most firms will generally comply with either GAAP or IFRS protocols.

The construction process involves multiple stages of aggregation, starting with individual journal entries and progressing through trial balances to final consolidated statements. Each line item represents countless underlying transactions, all traced back to source documents and verified for accuracy.

The assembly process requires consolidation procedures, particularly for multinational corporations with numerous subsidiaries. Accountants must eliminate intercompany transactions, translate foreign currencies, and ensure all adjustments comply with relevant accounting standards.

The Assembly and Review Process

The final assembly of a financial report involves multiple teams working towards a single deadline. This process typically begins with a kick-off meeting where project managers establish timelines, assign responsibilities, and coordinate between departments.

The assembly phase involves integrating all components – financial statements, MD&A, risk factors, and other required disclosures – into a cohesive document.

Quality control procedures include multiple rounds of review. Internal audit teams verify numerical accuracy and cross-reference figures throughout the document. Legal counsel ensures compliance with securities regulations and reviews all forward-looking statements. The disclosure committee, typically including the CEO, CFO, and General Counsel, provides final approval before external audit review.

The external audit process can add another layer of scrutiny. Auditors examine supporting documentation, test internal controls, and verify that financial statements comply with applicable standards. Their work often uncovers areas requiring adjustment or additional disclosure, leading to further revisions.

This iterative process continues until all parties are satisfied that the report accurately represents the company’s financial position and performance.

Final thoughts

Understanding how financial reports are created is the first step towards developing a comprehensive approach to stock analysis.

Once you know the basics, you can further develop your understanding by learning how to read a financial report, and interpret the headline events and more subtle nuances provided by these pivotal features of fundamental analysis.

Visit the eToro Academy to learn more ways to improve your analysis.

FAQs

How long does it typically take to construct a complete financial report?

The entire process usually takes 3-4 months from initial data collection to final filing. Large multinational corporations may require additional time due to complexity, while smaller companies might complete the process more quickly.

Who is ultimately responsible for the accuracy of financial reports?

The CEO and CFO bear ultimate responsibility, as evidenced by their required certifications under regulations like Sarbanes-Oxley. However, the construction involves numerous professionals including accountants, lawyers, and auditors.

How do companies ensure consistency across different sections of the report?

Companies employ project management systems and review protocols that cross-check information between sections. Dedicated teams ensure that numbers cited in the MD&A match the financial statements and that risk factors align with disclosed performance issues.

What is the difference between GAAP and IFRS?

The main difference between US GAAP (Generally Accepted Accounting Principles) and IFRS (International Financial Reporting Standards) is that GAAP is a rules-based system while IFRS is a principles-based system. The “rules-based” approach requires firms to comply with specific detailed accounting protocols, while the “principles” approach relies on professional judgment and the spirit of standards to provide consistent financial reporting. Another distinguishing feature is that GAAP is the dominant reporting procedure among U.S. companies, while IFRS is more widely adopted globally.

Is there a difference between an Annual Report and a 10-K filing?

Annual reports and 10-k filings may or may not contain the same information. A 10-k report is the document filed by publicly listed U.S. companies to the SEC. It follows SEC criteria, and provides details about their financial situation, operations and business plan. That comprehensive document can be shared with investors as the “Annual Report” or additional information can be added before it is released. For example, if a company’s management decides to elaborate on the company’s growth prospects.

What do terms like 10-K, 10-Q and 20-F refer to?

These terms are examples of the abbreviated codes which are used to categorise specific financial statements that are different in nature. Publicly listed US companies file 10-K and 10-Q reports with the SEC. The 10-K is an annual report and the 10-Q is created on a quarterly basis. The 20-F report is for “foreign private issuers” which are companies who have stock listed on a US exchange but where 50% or less of the total amount of voting shares are held by US citizens.