Your Financial Statements May Be More Valuable Than You Know
As a business performance expert, I rely heavily on the financial statements of my clients to determine the current condition of their companies. It’s the starting point for understanding where they are now. It’s the source of where to begin improvements and it’s the source to tell if improvements are working. When discussing financial statements with the company owners, I often find hear a common theme. Business owners tell me they are preparing financial statements so their accountant can prepare their taxes. Sometimes business owners do this many months, sometimes years after a particular month or year is over. For these business owners, they are losing out on the main way of improving their business performance: creatively structured financial statements. Because of this, they are not realizing the two main purposes of their financial statements: To prepare the tax return and to better manage their company. If you are one of these business owners not getting enough from your financial statements, then read more below, because you can benefit from using your financial statements to better run your company.
Financial statements for tax purposes
When you or your accountant prepares your financial statements for tax purposes, the goal is to get ready to report to the IRS your business taxable income. Let’s be clear about what I mean when I say financial statements. The IRS requires your balance sheet and your income statement, but not the statement of cash flow. This is because the balance sheet and income statement are required to be cash basis. This cash basis requirement eliminates the need for a cash flow statement. Because these financial statements are prepared for tax purposes, they are required to follow the tax laws for what you can and can’t report. For example, this means some expenses are allowed and some are not. Your revenues are also subject to the IRS rules. If you focus on the results that financial statements prepared according to tax law gives you, the results are very simple and very limited: You get your taxable business income according to the tax law. What these financial statements don’t tell you is how to better run your business. They were never prepared for this purpose.
Financial statements for management purposes
When your accountant prepares your financial statements for management purposes, you get a set of financial statements that allow you to better run your company. As a secondary bonus, you also get financial statements that can be used to prepare your taxes. By financial statements, I mean, at the very least, a balance sheet, an income statement and a cash flow statement. Each statement may be viewed in a variety of ways to provide you with things like summary views, detailed views and more. Having these views give you a variety of ways to judge your current business conditions and uncover needed improvements. Additional information is also at your fingertips to allow you to view far reaching corners of your company. For example, revenues by customer will allow you to see who your biggest customers are and whether you are in the risky situation of depending on a small number of clients to support your business.
Your financial statements have great flexibility in how they are structured to provide you with management information. The flexibility is only limited by your imagination for what information you design to best run your company. Want to see your revenues by product and service? Do you want your revenues grouped by lines of business? All are available in a single easy to read system. Each view gives you a different set of valuable information about what you are selling well and what you are not selling well. Other flexibilities may be done with costs and many other elements of your financial statements such as isolating detailed costs. One example of isolating detailed costs is viewing multiple rents in a complex rent arrangement such as a large franchise with hundreds of properties and hundreds of rent arrangements.
Your financial statements, when designed for management purposes are subject to Generally Accepted Accounting Principles. These principles may sound like there is a fixed way of doing things, and to some degree they are, however, nestled within the framework of Generally Accepted Accounting Principles, you have great flexibility to create what you need to run your own business your own way such as getting more details within revenue and expenses. I’ll spare you the effort of undertaking the accounting education required to actually be an accountant and perform Generally Accepted Accounting Principles on your own, but I will say that the accounting profession has built upon a body of knowledge so well over the many, many years of business experience that Generally Accepted Accounting Principles (GAAP) is the standard in financial statement reporting. The accounting industry recognizes the practices that yield lower quality financial information (non-GAAP) and encourages practices that become higher quality financial information (GAAP).
The accounting industry is so attuned to this standard and it’s importance, that GAAP is soon to become a new standard through a project known as “Convergence”. In this project The International Accounting Standards Board (IASB) and their standard of International Financial Reporting Standards (IFRS) and the US Financial Accounting Standards Board (FASB) and their standard of GAAP have been working on a project to converge these two standards into one. This means, once the convergence is completed, financial statements originating from any company in the world may be comparable to any other financial statements elsewhere in the world. Yes, this is a product of rapidly growing global economy.
When you prepare your financial statements for management purposes, you can get an unlimited amount of information available to better run your company, and in addition, you have a set of financial statements that can also serve your purposes of tax. That’s a two for one!
Your financial statements are more valuable than you know. Here’s Why:
Financial statement for tax purposes
- Has a single purpose of tax reporting
- Are prepared according to tax law
- Give the IRS what they need – your taxable business income
- Does not give you what you need to manage your company
Financial statements for management purposes
- Has dual purposes – running your company and tax reporting
- Are prepared according to Generally Accepted Accounting Principles
- soon to be a new standard
- Can be highly flexible to give you unlimited management information
I invite you to contact me if you have questions!
Rodger Stephens, CPA, CGMA
Prize Performance LLC is a consulting firm specializing in accelerating business performance for small to medium sized businesses. Contact Prize Performance LLC today to take your business to new places!