Definition: Financial statements for businesses usually include income statements, balance sheets, statements of and cash flows. (Investopedia.com).
Income Statement: The income statement covers a range of time (such as a calendar or fiscal year). The income statement provides an overview of revenues, expenses, net income.
Balance Sheet: The balance sheet provides an overview of assets, liabilities and stockholders’ equity as a snapshot in time. The date at the top of the balance sheet tells you when the snapshot was taken, which is generally the end of the fiscal year. The balance sheet equation is assets equal liabilities plus stockholders’ equity, because assets are paid for with either liabilities, such as debt, or stockholders’ equity, such as retained earnings and additional paid-in capital. Assets are listed on the balance sheet in order of liquidity. Liabilities are listed in the order in which they will be paid. Short-term or current liabilities are expected to be paid within the year, while long-term or noncurrent liabilities are debts expected to be paid after one year. (Investopedia.com).
Cash Flow Statement: The cash flow statement merges the balance sheet and the income statement. Due to accounting convention, net income can fall out of alignment with cash flow. The cash flow statement reconciles the income statement with the balance sheet. (Investopedia.com).
Tied together: It is common for a business owner to focus more on the income statement. Both the income statement and balance sheet are tied together and an accurate view of the income statement can be made only by looking at both statements simultaneously.
Errors: Very few privately-held companies have an accurate balance sheet. An erroneous balance sheet often also indicates an erroneous income statement.
Theft: Employee theft is usually hidden on a company’s balance sheet. An owner who does not understand and/or who does not have oversight on company’s accounting staff is inviting employee theft.
Decisions: Regardless of your intelligence, you increase the probability of making a bad decision if the information you are using to make decisions is erroneous. (The Danger Zone, Lost in the Growth Transition, p. 133).
Related parties: It is common for a business owner to own more than one company. These other companies may be wholly or partially-owned. These companies often have intercompany transactions, such as the lending of money, assets or the assumption of debt. A consolidation of wholly or partially-owned companies should be considered when determining if the financial statements of a company are accurate.
KPIs: Key performance indicators (KPIs) are a set of quantifiable measures that a company uses to gauge its performance over time. These metrics are used to determine a company’s progress in achieving its strategic and operational goals, and also to compare a company’s finances and performance against other businesses within its industry. (Investopedia.com). It is advised that an owner know the KPIs for its company and that period comparison be made of the company against its KPIs. (See Industry Comparative Report on The Discovery Analysis™ section on the home page of this website).
Accuracy: It is virtually impossible to ensure that financial statements are 100% accurate. The goal is that they are fairly presented and have no material errors. Some suggestions to improve accuracy might include the following.
- Know your company’s KPIs (Key Performance Indicators) and have those who prepare internal and external financial statements be responsible to report material changes of your company’s KPIs.
- Have regular oversight on those who issue monthly and annual financial statements.
- Owners should learn to understand and challenge the financial statement accuracy.
- Have an independent CPA firm issue an audit or review of the statements.
- Periodically ask the accounting department to “prove” the material numbers on financial statements.
- Properly vet the resumes of those who are hired into an accounting department. Unfortunately, overstating experience on resumes is a growing trend in our society.
- Consider having a third-party verification of a possible new hire’s criminal background.
- Have an employee manual that allows for periodic and random drug testing that complies with federal and state laws. Then, periodically drug test those who have any involvement with the accuracy of the financial statements of the company.