What if the Numbers Don’t Add up?

Posted on May 18, 2015 By

What if the Numbers Dont Add Up

While presenting business plans, the financial statement information should have perfectly balanced books and tie out.  The first thing what people think when reviewing your masterpiece, is what other problems are there?  Is any of this information reliable?  Should I even bother asking them another clarifying question?

Here are some common gaffes for financial statements and projections:

Retained Earnings

Not understanding or putting enough effort into making sure retained earnings is correct?  What is retained earnings?  It is the accumulated earnings of the corporation.  Each year, the net income and other items are rolled into it.  You can think of as a running balance.

What can go wrong?

  • Not setting up the equity accounts correctly, then hiding everything left over in the Retained Earnings Account.
  • I’ve seen people take it off because it’s a negative number and that would make them look bad.  I got news for you, making up fake numbers is bad.  This one is important, don’t run from it.  Most startups run a negative retained earnings balance.  Own it.
  • Not rolling over the Net Income and other items to Retained Earnings.

Cash

  • Not doing bank recs on a regular basis.  I know you probably have a bank load and that is handling everything for you.  But you should really take a glance at the transactions once in a while.
  • A good 50% of accounting mistakes can be fixed by reviewing cash.  Once you start reviewing the transactions, solutions to thorny issues will pop up.
  • Remember that most anyone can request an audit and compare your bank statement to the amount on your books.

Accounts Receivable

  • If you have written off customer accounts, you should clean them off the receivable list.  It can produce phantom income/sales that might disappear under a close examination.  Run an AR Aging reports to look for laggards.
  • Understand the GAAP Revenue Recognition rules for your industry.  There are specific legal rules for recognizing revenue that might adjust your receivables.

Fixed Assets

  • Understand the different Tax and GAAP categories for assets.
  • Incorrect Accumulated Depreciation.  I can’t tell you how many books that I’ve seen where the accountant didn’t bother posting the annual depreciation expense.  For years.  Run a depreciation report for your business assets and cross check to make sure the net book value is accurately calculated on your financials.
  • Disposing of destroyed or scrapped assets.  Again, very common.  Do you really still have that 10 year old laptop?

Intangible Assets

  • Goodwill, if you are looking for investors, they will looking at this number.  It could materially effect their funding involvement.  Make sure you can answer questions about it and the current valuation.
  • Patents & Licenses.  Like the goodwill, it’s a good idea to review the pertinent facts about the valuation.

Accounts Payable:

  • Not entering all the liabilities.  I think this is a newbie mistake.  Understating liabilities usually translates into artificially lowering your expenses. And that usually increases your net income.  Honestly, this is a classic work around for companies seeking investors since before the depression.  You want a stink eye from an auditor?
  • In QuickBooks, there is a flaw that allows you to write vendor checks without decreasing the liabilities.  The accountant correctly records the liabilities, but writes a direct check to the vendor.  Expenses are double counted.  Run an AR liability report and see how many items are still being carried on your books.  Fix it by deleting the check and reissue it as a liability payment.

Payroll Liabilities

  • Do you owe money to your employees or tax authorities?  The amounts should be clearly listed here.  This might require tweaking how your payroll downloads into your company PNL.
  • ADP and other payroll providers often
  • Vacation and other paid time off.  You will need to accrue the amount of money that you will need to pay if an employee leaves or takes their vacation.  The accrual is according to GAAP if you have an obligation to pay, ie. employee handbook or regulation.  While I’m not in favor of this plan, some tech companies have specifically removing vacation pay and carryovers and replacing with PTO or Paid Time off.  You should consult with your legal counsel or CPA firm before doing so.  It could have legal reprocussions or your valued employees might leave enmasse.

Loans and Long Term Liabilities

  • Record all of them.
  • The biggest mistake that I see here is not properly recording them according to GAAP.  The interest expense might be recorded to reduce liability expense.  I suggest creating an amortization schedule for the loan, cross checking with your lender about the outstanding liability.  Adjust accordenly.
  • Capital Lease.  Did you know that some leases are technically loans?  You should double check with your CPA and reread that long term lease agreement to learn more.  This can be a tricky subject.

Equity

  • Get it right.  If you need help with this section, make sure you get help.  Each business type has a specific equity structure in the books.

Profit and Loss

Sales and Revenue:

  • Make sure you are familar with GAAP rules for reporting income.  For some industries, it might not be as easy as you think.  Some triggers?  Long Term Contracts.  Long Term Commitments with a payment upfront.  Software Sales. Ownership transfers don’t occur until delivery.
  • Be as specific as you need to be and and as general as you need to be.  If you need to make a schedule to break out the market segments, make sure the totals tie out to the main financials.

Cost of Goods Sold:

  • Be familar with the rules.  Try not to hide any cogs expenses in the operating expenses.  Most common? Freight Expense.
  • If you are manufacturing, it’s helpful to know the difference between LIFO, FIFO and Average Cost.
  • Know what your overhead rate is.
  • Know at what point you need to increase capacity or production.  If you want to get fancy, even make a graph.

Operating Expenses

  • Run a transaction report for the general ledger.  Skim it to make sure that everything is in the correct category.
  • Have categories or general ledger accounts that tell your story.  If you are spending the lions share on marketing, break out some categories for online marketing, PPC, design, tradeshows, free samples and so on.
  • Clean up extra categories.  I’ve seen three different business license accounts.  State, County and City.  Don’t be that specific.  Create some sub accounts if it’s truly necessary to have that specific information recorded.

Okay, so that’s probably a bit much to ingest in one sitting.  🙂

Laura Dodson
Follow me

Laura Dodson

Laura Dodson, CPA is a Seattle Financial Planning & Analysis consultant.She has attended Western Washington University, Pierce College and Bates Technical College. She has written four accounting instructional books. She has worked for small family businesses, mid-sized businesses and a Fortune 500 company.She founded and operated Blue Stone Accounting LLC for five years.She currently runs Paper Butterfly Forge LLC.
Laura Dodson
Follow me

Latest posts by Laura Dodson (see all)

Uncategorized