6 Things You Didn't Know About Your Financial Statements
As a CPA, I’ve prepared and read thousands of financial statements just like yours. These are six things I bet you didn’t know about them:
1. As a management tool, they’re irrelevant without an explanation. A typical financial statement, even one created internally, is usually not delivered until two to three weeks after a period end. For a business, that’s light years. A financial statement is only relevant when it’s accompanied by someone’s analysis. It’s why certified financials have footnotes. It’s why public companies include a management’s discussion and analysis with their publicly filed data. And it’s why your bookkeeper, accounting manager or controller should include an accompanying narrative highlighting major trends, issues and red flags that are still a concern.
A balance sheet and profit and loss statement from weeks ago with no commentary is as valuable as a newspaper from that same time: anecdotal and amusing -- but not very useful. Want something more useful? My best clients get daily “flash reports” of key financial data -- YTD sales, expenses, cash balances, payroll hours, backlog, etc. They use this information to run their businesses. They use their financial statements to appease the bankers.
2. Your accountant’s report is generally meaningless. Ever read the accountant’s report that accompanies your financials? You should. And you’ll laugh. Even if the accountant performed a full-blown audit -- and this is unlikely, because, unless you’re a public company or have serious obligations, there’s no way you’re going to pay the fees required -- you’ll be amazed at the lack of ownership the accountant assumes. Even the first paragraph says, “these financial statements are the responsibility of the company’s management.” The auditor at best had “reasonable assurance” and the financials at best are free of “material misstatement.” The whole opinion is made on a “reasonable basis.” You’ll be asked to sign off engagement and representation letters too, which the accountant can fall back on in case there’s a problem. The uptake? You own these financials so you better understand and take ownership of every single line item. Your accountant won’t.
3. Your tax return is rarely the same as your financial statements. Separate rules apply. Assets are valued differently. Some expenses are not expenses. Some revenues are accounted for differently. You might show a loss on your financials, but a profit on your tax return. Or the opposite. Make sure to understand how these reconcile.
4. Your assets are lower and your liabilities are higher than you think. Your bad receivables might be “reserved,” but they’re not written off. Your “other assets” contain stupid things like “prepaid insurance,” which may be an asset for accounting purposes but for a business owner it’s already cash out the door for something you’ll never get back. Your inventory is probably not worth as much as your financials say and your capital equipment doesn’t reflect the annual maintenance and repairs required to keep running. Your income statement doesn’t show the cash you paid out during the year for prior and estimated taxes, inventory you purchased but haven’t sold, machinery bought, loan payments made to the bank or distributions to your partners, which is why you’re scratching your head over the fact that it’s showing profits but you still have no cash in the bank.
5. Your banker doesn't rely too heavily on your financials. Banks usually require financial statements from their customers, but they’re more interested in getting your monthly reports, aged receivables and accounts payable listing. When they get your financials, they’ll quickly go into spreadsheet mode, sticking numbers into the right places so they can confirm compliance with their covenants, checking your debt to equity and making triple-sure you can service your loans. Then they’ll tick off “financial statements” from the annual checklist. Every good banker knows that if there’s a problem, it won’t be found in the financials. It will be found through conversations, site visits and checking more current data. If your banker is just using your financial statements to uncover an issue then he won't be in the banking business for very long.
6. Your financials have little do to with your company’s market value. Investors don’t buy stocks based on a company’s past financials. A buyer won’t purchase your interest just because you had a good year. The past is not the future, and smart investors put their money into the future. They are interested in your backlog, people, product research, future revenue streams, growth, your customers’ growth and a hundred other things. These are not things you will find on your financial statements.
So go ahead, have those financial statements prepared. Some may get value from them. But not a lot.