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Private business owners: Don’t wait until year end to evaluate financial performance

Greencrest on June 10, 2022

How often does your company generate a full set of financial statements? It’s common for smaller businesses to issue only year-end financials, but interim reporting can be helpful, particularly in times of uncertainty. Given today’s geopolitical risks, mounting inflation and rising costs, it’s wise to perform a midyear check-in to monitor your year-to-date performance. Based on the results, you can then pivot to take advantage of emerging opportunities and minimize unexpected threats.

Appreciate the diagnostic benefits

Monthly, quarterly and midyear financial reports can provide insight into trends and possible weaknesses. Interim reporting can be especially helpful for businesses that have been struggling during the pandemic.

For example, you might compare year-to-date revenue for 2022 against your annual budget. If your business isn’t growing or achieving its goals, find out why. Perhaps you need to provide additional sales incentives, implement a new ad campaign or alter your pricing. It’s also important to track costs during an inflationary market. If your business is starting to lose money, you might need to consider 1) raising prices or 2) cutting discretionary spending. For instance, you might need to temporarily scale back on your hours of operation, reduce travel expenses or implement a hiring freeze.

Don’t forget the balance sheet. Reviewing major categories of assets and liabilities can help detect working capital problems before they spiral out of control. For instance, a buildup of accounts receivable may signal collection problems. A low stock of key inventory items might foreshadow delayed shipments and customer complaints, signaling an urgent need to find alternative suppliers. Or, if your company is drawing heavily on its line of credit, your operations might not be generating sufficient cash flow.

Recognize potential shortcomings

When interim financials seem out of whack, don’t panic. Some anomalies may not be caused by problems in your daily business operations. Instead, they might result from informal accounting practices that are common midyear (but are corrected by you or your CPA before year-end statements are issued).

For example, some controllers might liberally interpret period “cutoffs” or use subjective estimates for certain account balances and expenses. In addition, interim financial statements typically exclude costly year-end expenses, such as profit sharing and shareholder bonuses. Interim financial statements, therefore, tend to paint a rosier picture of a company’s performance than its year-end report potentially may.

Furthermore, many companies perform time-consuming physical inventory counts exclusively at year end. Therefore, the inventory amount shown on the interim balance sheet might be based solely on computer inventory schedules or, in some instances, management’s estimate using historic gross margins. Similarly, accounts receivable may be overstated, because overworked finance managers may lack time or personnel to adequately evaluate whether the interim balance contains any bad debts.

Proceed with caution

Contact us to help with your interim reporting needs. We can fix any shortcomings by performing additional procedures on interim financials prepared in-house — or by preparing audited or reviewed midyear statements that conform to U.S. Generally Accepted Accounting Principles.

Dig deeper! Find hidden treasure in financial statement footnotes

Greencrest on June 3, 2022

Numbers tell only part of the story. Comprehensive footnote disclosures, which are found at the end of reviewed and audited financial statements, provide valuable insight into a company’s operations. Unfortunately, most people don’t take the time to read footnotes in full, causing them to overlook key details. Here are some examples of hidden risk factors that may be unearthed by reading footnote disclosures.

Related-party transactions

Companies may give preferential treatment to, or receive it from, related parties. Footnotes are supposed to disclose related parties with whom the company conducts business.

For example, say a tool and die shop rents space from the owner’s parents at a below-market rate, saving roughly $120,000 each year. Because the shop doesn’t disclose that this favorable related-party deal exists, the business appears more profitable on the face of its income statement than it really is. If the owner’s parents unexpectedly die — and the owner’s brother, who inherits the real estate, raises the rent to the current market rate — the business could fall on hard times, and the stakeholders could be blindsided by the undisclosed related-party risk.

Accounting changes

Footnotes disclose the nature and justification for a change in accounting principle, as well as that change’s effect on the financial statements. Valid reasons exist to change an accounting method, such as a regulatory mandate. But dishonest managers can use accounting changes in, say, depreciation or inventory reporting methods to manipulate financial results.

Unreported and contingent liabilities

A company’s balance sheet might not reflect all future obligations. Detailed footnotes may reveal, for example, a potentially damaging lawsuit, an IRS inquiry or an environmental claim. Footnotes also spell out the details of loan terms, warranties, contingent liabilities and leases.

Significant events

Outside stakeholders appreciate a forewarning of impending problems, such as the recent loss of a major customer or stricter regulations in effect for the coming year. Footnotes disclose significant events that could materially impact future earnings or impair business value.

Transparency is key

In today’s uncertain marketplace, it’s common for investors, lenders and other stakeholders to ask questions about your disclosures and request supporting documentation to help them make better-informed decisions. We can help you draft clear, concise footnotes and address stakeholder concerns. On the flip side, we can also discuss concerns that arise when reviewing disclosures made by publicly traded competitors and potential M&A targets. Contact us for more information.

Contingent liabilities: To report or not to report?

Greencrest on May 31, 2022

Disclosure of contingent liabilities — such as those associated with pending litigation or government investigations — is a gray area in financial reporting. It’s important to keep investors and lenders informed of risks that may affect a company’s future performance. But companies also want to avoid alarming stakeholders with losses that are unlikely to occur or disclosing their litigation strategies.

Understanding the GAAP requirements

Under Accounting Standards Codification (ASC) Topic 450, Contingencies, a company is required to classify contingent losses under the following categories:

Remote. If a contingent loss is remote, the chances that a loss will occur are slight. No disclosure or accrual is usually required for remote contingencies.

Probable. If a contingent loss is probable, it’s likely to occur and the company must record an accrual on the balance sheet and a loss on the income statement if the amount (or a range of amounts) can be reasonably estimated. Otherwise, the company should disclose the nature of the contingency and explain why the amount can’t be estimated. In general, there should be enough disclosure about a probable contingency so the disclosure’s reader can understand its magnitude.

Reasonably possible. If a contingent loss is reasonably possible, it falls somewhere between remote and probable. Here, the company must disclose it but doesn’t need to record an accrual. The disclosure should include an estimate of the amount (or the range of amounts) of the contingent loss or an explanation of why it can’t be estimated.

Making judgment calls

Determining the appropriate classification for a contingent loss requires judgment. It’s important to consider all scenarios and document your analysis of the classification.

In today’s volatile marketplace, conditions can unexpectedly change. You should re-evaluate contingencies each reporting period to determine whether your previous classification remains appropriate. For example, a remote contingent loss may become probable during the reporting period — or you might have additional information about a reasonably possible or probable contingent loss to be able to report an accrual (or update a previous estimate).

Outside expertise

Ultimately, management decides how to classify contingent liabilities. But external auditors will assess the company’s existing classifications and accruals to determine whether they seem appropriate. They’ll also look out for new contingencies that aren’t yet recorded. During fieldwork, your auditors may ask for supporting documentation and recommend adjustments to estimates and disclosures, if necessary, based on current market conditions. Contact us for more information.

Forecasts vs. projections: What’s the big difference?

Greencrest on May 13, 2022

Financial statements look at historical performance. But there are times when you want forward-looking reports to help your business make strategic investment decisions, evaluate the viability of a turnaround plan or apply for a loan. Your accountant can help ensure the assumptions underlying prospective financial statements make sense in today’s volatile marketplace.

Key definitions

When creating forward-looking financials, you generally have two options under AICPA Attestation Standards Section 301, Financial Forecasts and Projections:

1. Forecast. Prospective financial statements that present, to the best of the responsible party’s knowledge and belief, an entity’s expected financial position, results of operations and cash flows. A financial forecast is based on the responsible party’s assumptions reflecting the conditions it expects to exist and the course of action it expects to take.

2. Projection. Prospective financial statements that present, to the best of the responsible party’s knowledge and belief, given one or more hypothetical assumptions, an entity’s expected financial position, results of operations and cash flows. A financial projection is sometimes prepared to present one or more hypothetical courses of action for evaluation, as in response to a question such as, “What would happen if … ?”

Subtle difference

The terms “forecast” and “projection” are sometimes used interchangeably. But there’s a noteworthy distinction, a forecast represents expected results based on the expected course of action. These are the most common type of prospective reports for companies with steady historical performance that plan to maintain the status quo.

On the flip side, a projection estimates the company’s expected results based on various hypothetical situations that may or may not occur. These statements are typically used when management is uncertain whether performance targets will be met. So, they may be appropriate for start-ups or when evaluating results over a longer period because there’s a good chance that customer demand or market conditions could change over time.

Critical components

Regardless of whether you opt for a forecast or projection, the report will generally be organized using the same format as your financial statements with an income statement, balance sheet and cash flow statement. Most prospective statements conclude with a statement of key assumptions that underlie the numbers. Many assumptions are driven by your company’s historical financial statements, along with a detailed sales budget for the year.

Instead of relying on static forecasts or projections — which can quickly become outdated in a volatile marketplace — some companies now use rolling 12-month versions that are adaptable and look beyond year end. This helps you identify and respond to weaknesses in your assumptions, as well as unexpected changes in the marketplace. For example, a manufacturer that experiences a shortage of raw materials could experience an unexpected drop in sales until conditions improve. If the company maintains a rolling forecast, it would be able to revise its plans for such a temporary disruption.

Contact us

Planning for the future is an important part of running a successful business. While no forecast or projection will be 100% accurate in these uncertain times, we can help you evaluate the alternatives for issuing prospective financial statements and offer fresh, objective insights about what may lie ahead for your business.

Caring for an elderly relative? You may be eligible for tax breaks

Greencrest on May 10, 2022

Taking care of an elderly parent or grandparent may provide more than just personal satisfaction. You could also be eligible for tax breaks. Here’s a rundown of some of them.

Medical expenses. If the individual qualifies as your “medical dependent,” and you itemize deductions on your tax return, you can include any medical expenses you incur for the individual along with your own when determining your medical deduction. The test for determining whether an individual qualifies as your “medical dependent” is less stringent than that used to determine whether an individual is your “dependent,” which is discussed below. In general, an individual qualifies as a medical dependent if you provide over 50% of his or her support, including medical costs.

However, bear in mind that medical expenses are deductible only to the extent they exceed 7.5% of your adjusted gross income (AGI).

The costs of qualified long-term care services required by a chronically ill individual and eligible long-term care insurance premiums are included in the definition of deductible medical expenses. There’s an annual cap on the amount of premiums that can be deducted. The cap is based on age, going as high as $5,640 for 2022 for an individual over 70.

Filing status. If you aren’t married, you may qualify for “head of household” status by virtue of the individual you’re caring for. You can claim this status if:

The person you’re caring for lives in your household,
You cover more than half the household costs,
The person qualifies as your “dependent,” and
The person is a relative.

If the person you’re caring for is your parent, the person doesn’t need to live with you, so long as you provide more than half of the person’s household costs and the person qualifies as your dependent. A head of household has a higher standard deduction and lower tax rates than a single filer.

Tests for determining whether your loved one is a “dependent.” Dependency exemptions are suspended (or disallowed) for 2018–2025. Even though the dependency exemption is currently suspended, the dependencytests still apply when it comes to determining whether a taxpayer is entitled to various other tax benefits, such as head-of-household filing status.

For an individual to qualify as your “dependent,” the following must be true for the tax year at issue:

You must provide more than 50% of the individual’s support costs,
The individual must either live with you or be related,
The individual must not have gross income in excess of an inflation-adjusted exemption amount,
The individual can’t file a joint return for the year, and
The individual must be a U.S. citizen or a resident of the U.S., Canada or Mexico.

Dependent care credit. If the cared-for individual qualifies as your dependent, lives with you, and physically or mentally can’t take care of him- or herself, you may qualify for the dependent care credit for costs you incur for the individual’s care to enable you and your spouse to go to work.

Contact us if you’d like to further discuss the tax aspects of financially supporting and caring for an elderly relative.

Category: Business

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