Importance Of Transparency In Financial Reporting

No one can ignore the importance of transparency in financial reporting, because people make big decisions regarding the investments based on financial reporting. Every investor wishes that he should be able to get more, better and transparent information about the financial data of the company. In fact, it is the quality of report, which helps investors in making certain investment decision. Irony is that some companies prepare financial reports, which are the tools for giving insight to the investor, in such a way that rather than providing required information correctly they skillfully hide the facts. It is advisable to the investors that those companies who do not understand the importance of transparency in financial reporting should be avoided. Making investments in such companies is more risky and less valuable.

Meaning Of the Word Transparent;

Before discussing importance of transparency in financial reporting, let us first understand what the word transparent means. The best definition of transparent in business circles is financial statements of high quality. There are so many definitions in the dictionary. However, the relevant here are “very clear,” “easily understood,” “candid” and “frank.”

Let us understand the importance of transparency in financial reporting with the help of an example. Think of two companies having similar financial leverage, market capitalization and overall market risk exposure. Take for granted that the earnings, growth rate of earnings and Return On Capital (ROC) is also same. They have only one difference and that only difference is very crucial for the market analysts. First company is running only one business and the financial reporting is easy to understand. On the contrary, second company is involved in running several types of businesses and has complex financial reporting. Now you would like to prefer making investment in which company. Chances are more that experts will favor the first company because of simplicity and transparency in financial reporting.

Companies, that understand the importance of transparency in financial reporting, are also well informed about the psychology of the investors. A complex and opaque financial reporting gives no idea about the true risks involved and real fundamentals of the company. Here is a simple example of this. An important indicator of future growth of a company is how it has invested the money. When after going through the financial reports, you cannot find any concrete information regarding the investments made by the company because of so many holding companies, and then evaluating investments becomes difficult. Obscure statements also hide the level of debt, thereby also hiding if the company is on the brink of bankruptcy.