Why do you need reliable financial reporting?
While it is intuitively obvious that every company needs reliable financial reporting in support of the company mission, whether it is a for-profit or not-for-profit enterprise, it is often an area of the company which is neglected or looked upon as a necessary, but unwelcome, expense. However, companies that thrive in the longer term typically have high quality financial reporting and include the financial management team in all major business decisions.
Preparing precise financial statements are critical to all stake holders. Business owners, operators, creditors, bankers and regulators all rely on accurate and timely financial reporting to determine the financial stability of the business and the strength and reliability of its operating results. The preparers of financial statements are the linchpin of high quality, reliable and timely financial reporting and often have the difficult task of challenging management on transactions, judgements, and risk areas.
Who is responsible for preparing reliable financial statements?
Maintaining accurate, complete and timely financial statements is the responsibility of management and should be a top priority of the CEO to support the company’s decision-making process. Far too often a business uses untimely and unreliable financial data to perform fundamental analysis. This failure is exacerbated by the fact that many management teams do not fully understand how to interpret the financial results presented. This is particularly prevalent in small to mid-size private businesses where there is a lack of understanding of how financial reports, including income statements, balance sheets and cash flow statements, reflect the health of the company. Unaddressed problems, which could have been identified by sound financial reporting, can lead to the distress or failure of an otherwise viable company.
What can happen when financial statements are not properly prepared?
There are numerous risks which can occur when you don’t have reliable financial statements prepared on a regular basis using a systematic approach. These can include:
- Poor Decision-Making – Using incorrect core information that has not been properly reconciled or analyzed can lead to poor decisions made by the operating and financial management.
- Erosion of Confidence – Inaccurate financial reporting can erode the confidence of investors, bankers and suppliers, resulting in issues such as obtaining credit from vendors or needed funding from lenders and investors. Vendors may also charge higher prices for critical materials or supplies due to perceived future operating risks.
- Compliance Failures – Lack of timely and accurate financial reporting can lead to missed compliance deadlines for reporting to investors, regulatory agencies and financial institutions. Such delays are frequently interpreted as reflecting fundamental issues with business internal controls, which may not necessarily be the case.
- Fraud or Misappropriation – Internal fraud often results from a combination of inadequate review of financial key performance metrics and insufficient discipline around internal financial controls, leaving the company exposed. This is particularly prevalent in smaller companies where it is difficult to ensure the proper division of duties.
- Valuation Issues – Historical presentation of the company’s financial performance is a key indicator of future performance. The ability to present consistently prepared financials that identify positive trends can result in a significant premium on a company’s valuation. Conversely, when the financial history reflects numerous anomalies and variability that don’t necessarily match the operations tempo of the business, but instead are the result of inaccurate and inconsistent reporting, then the potential value of the business can be negatively impacted as a potential buyer’s confidence is eroded.
- External Review & Audit Issues – Having a consistent and timely reporting package that is substantially supported enables auditors and other external professionals to perform their reviews with less disruption to the business and at a far lower cost. Not having reliable financial reports and systems can lead to significant delays, increased costs and even fines or penalties from external auditors and professionals performing reviews on the company.
How do you prepare reliable financial reports?
The reliability principle is the concept of only recording those transactions in the accounting system that you can verify with objective evidence. Examples of objective evidence are sales orders, purchase receipts, invoices, cancelled checks, bank statements, promissory notes and appraisal reports. To prepare reliable financial statements, you need policies and procedures that define how these transactions are recorded in the financial system of record.
Depending on the size of the company and the volume of transactions, these financial reporting systems range from simple accounting software packages with basic recording capability to sophisticated Enterprise Resource Planning (ERP) systems, which manage day-to-day business activities such as accounting, human resources, payroll, procurement, project management, risk management, compliance and supply chain operations.
No matter the size of the company, financial information that is timely, accurate, reliable and usable is required to facilitate decision-making and answer questions from the wide variety of internal and external stakeholders in the company. Financial management and especially the CFO are tasked to work with these stakeholders to determine what each constituency needs, ensuring that those needs are met with accurate and usable reports.
It is also critical that the preparers of financial reports ensure that the high-quality, reliable reports they create meet the objectives and principles of Generally Accepted Accounting Principles (GAAP). Preparing financial statements on what is known as a “cash basis” is a tax concept which, while meeting the standards for preparing tax returns, are woefully inadequate for producing the information needed to run a growing company of any size. The importance of having properly prepared GAAP financials is highlighted by the investment sectors use of what are called non-GAAP measures. These measures can be significantly misstated if the base financials are not prepared according to GAAP.
What makes a good financial reporting package?
A financial package should tell the story of the company from a financial and operating perspective in a way that is useful to all stakeholders, serving as the “one source of truth.” Too many times, a company will attempt to prepare different reporting packages for management, the Board, bankers and sureties, when a single package can suffice. Once the core package is developed, it can be separated to provide the required level of information to different stakeholders.
However, there are some basic rules about what should be included in the preparation of a robust financial reporting package:
- Key Performance Indicators (KPIs) – KPIs are a set of quantifiable measurements used to gauge a company’s overall long-term performance. KPIs capture information regarding profitability, liquidity, efficiency and valuation, and they are used to guide decisions about a company’s strategic, financial and operational path. There are many KPIs relevant to different businesses, so carefully determining which ones are relevant to your business is critical.
- Trended Financial Statements – Financial statements include the income statement, balance sheet and cash flow statements and should include enough detail for various users to review at the level for which they are responsible. For example, the CEO and CFO may simply look at the consolidated statements to determine whether they met expected performance levels by comparison to the budget. The Controller may delve a little deeper to see that the individual division statements are correctly prepared and that all reconciliations are complete and accurate. Regardless of the level of review, having “trended” financials that reflect not only the current month’s performance, but also some of the previous months, is critical for proper analysis. Typically, a trended financial statement will reflect the current month and the previous 11 months. This is referred to as trailing 12-month reporting.
- Balance Sheet Reconciliations – All balance sheet accounts should be properly reconciled. Reconciliations are not simply roll-forwards but must include a description of what actually is included in the account at the transaction level. Movement in balance sheet accounts have a significant impact on the income statement and cash flow statement, so identifying balance sheet anomalies on a timely basis ensures that any significant movement is understood, and misstatements can be quickly rectified.
Should you outsource to prepare reliable financials?
Most companies typically use an accounting software to produce a standard set of financial statements, along with someone (or a team of people) in the accounting department overseeing that task. For some, this approach works well; but for many others, they could experience a myriad of issues with completing this reporting task with accuracy and reliability. Sometimes they simply need more support as they experience growth. If you answer “yes” to any of the following questions, chances are you’re ready to outsource some or all the activities related to your financial reporting.
- Do I lack confidence in my finance/accounting department?
- Does my finance team struggle to keep pace with the growth of the company?
- Do I need help with the increasing complexity of my business?
- Am I preparing my company for sale?
- Do we need improvement to our overall business processes?
- Am I ready to put the company in a better position for growth?
- Does the company need a valuation?
When outsourcing the activities required to improve the quality, reliability and consistency of your financial reporting, it is very important that you take the time to understand what needs improvement within your existing environment. This should be documented and shared with the advisor and external resources you are bringing on to ensure that you and your advisor are clear about the task. Many times, the outsourcing option allows you to insert highly qualified resources that can help design and implement improvements in a manner that either existing or new staff can then take forward at a much lower cost. In the long-term this can be a much more effective approach than attempting to do improvements in-house using a trial-and-error approach.
How can Windham Brannon help you with your financial reporting?
Windham Brannon has a strong team of experienced professionals with complementary skillsets that can be mobilized to evaluate, design and implement the improvements our clients need in order to deliver reliable financials with confidence. Our professionals have significant hands-on experience in many industries that allows us to make the recommendations needed to help you and your business grow organically or through acquisition.
For more information, reach out to your Windham Brannon advisor, or contact Laura Berry.
