Accurate, timely financial information is key to making good decisions for executives, board members, investors, and other stakeholders. But not everyone who reads your financial statements will really understand the numbers they receive and what they mean to your organization. Here are some ways to present your financial results in a reader-friendly manner.

Consider your audience

The people who rely on your organization’s financial statements probably come from different walks of life and different positions. Some may have financial backgrounds, but others might not. And it’s this latter group you need to keep in mind as you supply financial data.

This is especially true for nonprofits, such as charities, religious organizations, recreational clubs and social advocacy groups. Their stakeholders may include board members, volunteers, donors, grant makers, watchdog groups and other people in the community. But it also may apply to for-profit businesses that share financial data with their boards, employees and investors who don’t have a controlling interest in the organization.

Don’t assume all your stakeholders understand accounting jargon. It may be helpful to provide definitions of certain financial reporting terms. For example, a nonprofit might explain that “board-designated net assets” refers to items set aside for a particular purpose or period by the board. Examples include safety reserves or a capital replacement fund, which have no external restrictions by donors or by law. While this definition might seem obvious to a nonprofit’s management team, stakeholders might not be familiar with it. You could also provide internal stakeholders with some basic financial training by bringing in outside speakers, such as accountants, investment advisors, and bankers.

Add pictures to get your message across

In addition to providing numerical information from your company’s income statement, balance sheet and statement of cash flows, consider presenting some information in a graphical format. Long lists of numbers can have a dizzying effect on financial statement readers. Pictures may be easier for laypeople to digest than numbers and text alone.

For instance, you might use a pie graph to show the composition of your company’s assets. Likewise, a line or bar graph might be an effective way to communicate revenue, expenses, and profit trends over time.

Present financial ratios

Financial ratios show relationships between key items on your financial statements. While ratios don’t appear on the face of your financial statements, you can highlight them when communicating results to stakeholders. For instance, you might report the days in receivables ratios (accounts receivable divided by annual revenue times 365 days) from the current and prior reporting periods to demonstrate your efforts to improve collections. Or you might calculate gross margin (revenue minus cost of goods sold) as a percentage of revenue from the current and prior reporting periods to show how increases in raw materials and labor costs have affected your business’s profitability.

Another useful tool is the “current ratio.” A comparison of current assets to current liabilities is commonly used as a measure of short-term liquidity. A ratio of 1:1 means an organization would have just enough cash to cover current liabilities if it ceased operations and converted current assets to cash.

It may also be helpful to provide industry benchmarks to show how your company’s performance compares to others in your industry. This information is often available from industry trade publications and websites.

Be transparent about non-GAAP metrics

One area of particular concern is how your organization presents financial information that doesn’t conform to U.S. Generally Accepted Accounting Principles (GAAP), such as earnings before interest, taxes, depreciation, and amortization (EBITDA). The use of non-GAAP metrics has grown in recent years. While non-GAAP metrics can provide greater insight into the information that management considers important in operating the business, take care not to mislead stakeholders by putting greater emphasis on non-GAAP metrics than the GAAP data provided in your financial statements.

For instance, EBITDA is often adjusted for such items as stock-based compensation, nonrecurring items, intangibles and other company-specific items. If you report EBITDA, you should clearly disclose how it was calculated, including any adjustments, and how it compares to earnings before tax on your GAAP income statement.

Use plain English

Regardless of your industry, stakeholders want accurate, transparent information about your organization’s financial performance. It’s up to you to supply them with information they fully understand so they can make informed decisions. Contact us for help communicating your results more effectively to give stakeholders greater confidence and clarity when reviewing your financial reports.

Many people dream of turning a hobby into a regular business. Perhaps you enjoy boating and would like to open a charter fishing business. Or maybe you’d like to turn your sewing or photography skills into an income-producing business.

You probably won’t have any tax headaches if your new business is profitable over a certain period of time. But what if the new enterprise consistently generates losses (your deductions exceed income), and you claim them on your tax return? You can generally deduct losses for expenses incurred in a bona fide business. However, the IRS may step in and say the venture is a hobby — an activity not engaged in for profit — rather than a business. Then you’ll be unable to deduct losses.

By contrast, if the new enterprise isn’t affected by the hobby loss rules, all otherwise allowable expenses are deductible, generally on Schedule C, even if they exceed income from the enterprise.

Important: Before 2018, deductible hobby expenses could be claimed as miscellaneous itemized deductions subject to a 2%-of-AGI “floor.” However, because miscellaneous deductions aren’t allowed from 2018 through 2025, deductible hobby expenses are effectively wiped out from 2018 through 2025.

How to NOT be deemed a hobby

There are two ways to avoid the hobby loss rules:

1. Show a profit in at least three out of five consecutive years (two out of seven years for breeding, training, showing, or racing horses).
2. Run the venture in such a way as to show that you intend to turn it into a profit maker rather than a mere hobby. The IRS regs themselves say that the hobby loss rules won’t apply if the facts and circumstances show that you have a profit-making objective.

How can you prove you have a profit-making objective? You should operate the venture in a businesslike manner. The IRS and the courts will look at the following factors:

• How you run the activity,
• Your expertise in the area (and your advisors’ expertise),
• The time and effort you expend in the enterprise,
• Whether there’s an expectation that the assets used in the activity will rise in value,
• Your success in carrying on other activities,
• Your history of income or loss in the activity,
• The amount of any occasional profits earned,
• Your financial status, and
• Whether the activity involves elements of personal pleasure or recreation.

Case illustrates the issues

In one court case, partners operated a farm that bought, sold, bred, and raced Standardbred horses. It didn’t qualify as an activity engaged in for profit, according to a U.S. Appeals Court. The court noted that the partnership had a substantial loss history and paid for personal expenses. Also, the taxpayers kept inaccurate records, had no business plan, earned significant income from other sources, and derived personal pleasure from the activity. (Skolnick, CA 3, 3/8/23)

Contact us for more details on turning a hobby into a business, including whether you may be affected by the hobby loss rules and what you should do to avoid tax problems.

Earth Day (April 22) is a good time to evaluate what your business can do to protect the planet’s natural resources for the next generation. “Green” initiatives can demonstrate your company’s commitment to responsible business practices — as well as lower your monthly bills.

For many small and midsized businesses, utilities and fuel are significant monthly expenses. In recognition of Earth Day, here are six cost-effective ways to rethink energy usage and boost your bottom line:

1. Install smart thermostats.

This can save on heating costs in the winter and cooling costs in the summer. Smart thermostats adjust energy usage based on the presence of employees, the time of day, and your temperature preferences. Smart thermostats that meet Energy Star criteria save users an average of 8% on their utility bills, according to the U.S. Environmental Protection Agency.

You also might consider adjusting your current temperature settings by a degree or two (higher in the summer and lower in the winter) and programming thermostats to energy-saving mode during nonwork hours. Minor changes will compound over time.

2. Insulate and seal your facilities.

Heating and cooling systems can be particularly costly in uninsulated, leaky buildings. Installing spray foam and replacing old seals or adding new ones can dramatically reduce energy costs.

3. Invest in energy-efficient fixed assets.

Technological advances allow today’s equipment to consume less energy than older versions. Examples of older equipment that you should consider replacing with models that carry the Energy Star label include printers, copiers, scanners, computers and monitors.

Likewise, if your employees drive company vehicles or use gas-powered machinery or tools, consider efficiency ratings when it’s time to replace these assets. In some cases, it might make sense to switch to electric or hybrid alternatives.

4. Stay atop HVAC maintenance.

Heating, ventilation, and air conditioning (HVAC) systems depend on the unimpeded movement of air. Annual checkups can reveal blockages or leaks that can put additional stress on the equipment. Cleaning and replacing filters, as recommended, can also help lower energy usage.

5. Install LED lighting.

Light-emitting diode (LED) lighting is more energy efficient and lasts longer than regular incandescent lighting. LED lights are also easily dimmed, reducing the cost of lighting a space. Plus, LED lights emit less heat than incandescents, which can help lower room temperature in the summer.

6. Conduct an energy audit.

Audits can uncover areas of excessive usage and waste. While some utility companies offer free on-site consultations, third-party energy audit firms are a more comprehensive option. The audit process begins by establishing baseline expenses for such items as:
• Electricity,
• Natural gas,
• Fuel,
• Water, and
• Solid waste.

To prepare for an energy audit, you’ll need to gather these monthly expenses from the last two or three years. Looking back can help identify any variances, allowing you to investigate the root causes. You’ll also need to gather maintenance records and specifications — including square footage, year of construction, usage and operating hours — for each facility you operate. A list of energy-consuming assets — such as machines, equipment, lighting and HVAC systems, and vehicles — is also essential. The auditor will physically inspect your facilities and interview employees to identify problem areas and recommend potential energy-saving opportunities.

Go green, save green

While some of these recommendations require an investment, the cost savings can be significant and long-lasting. Contact us to discuss ways to lower your company’s energy costs and boost profits, including information about potential tax breaks that may be available for green improvements.

Inventory management is a key balance sheet item for many companies. Depending on the nature of your operations, inventory may include raw materials, work-in-progress (WIP) inventory, and finished goods. While you need to have enough inventory on hand to meet your customers’ needs, carrying excessive amounts can be costly. Here are some smart ways to manage inventory more efficiently — without compromising revenue and customer service.

Reliable counts

Effective inventory management starts with a physical inventory count. This exercise provides a snapshot of how much inventory your company has on hand at that point in time. For example, a manufacturing plant might need to count what’s on its warehouse shelves, on the shop floor and shipping dock, on consignment, at the repair shop, at remote or public warehouses, and in transit from suppliers and between company locations.

The value of inventory is always in flux, as work is performed and items are delivered or shipped. To capture a static value as of the reporting day, companies may “freeze” business operations while counting inventory. Usually, it makes sense to conduct counts during off-hours to minimize the disruption to business operations. For larger organizations with multiple locations, it may not be possible to count everything at once. So, larger companies often break down their counts by physical location.

Accuracy is essential to knowing your cost of goods sold, as well as to identifying and remedying discrepancies between your physical count and perpetual inventory records. Possible reasons for discrepancies include:

• Data entry errors,
• Inaccurate bin or part numbers,
• Shipping errors,
• Inventory in the authorized possession of employees (such as owners or salespeople),
• Theft, and
• Intentional financial misstatement.

It’s important to identify what’s happening and resolve any problems or errors.

Benchmarking studies

The next step is to compare your inventory costs to those of other companies in your industry. Trade associations often publish benchmarks for:

• Gross margin [(revenue – cost of goods sold) / revenue],
• Net profit margin (net income/revenue), and
• Days in inventory (annual revenue / average inventory × 365 days).

Your company should strive to meet — or beat — industry standards. For a retailer or wholesaler, inventory is simply purchased from manufacturers. However, inventory is more complicated for manufacturers and construction firms. These entities must allocate costs to projects that are in progress.

Efficiency measures

What can you do to improve your inventory metrics? The composition of your company’s cost of goods will guide you on where to cut. In today’s tight labor market, it may be difficult to reduce labor costs. But it may be possible to renegotiate prices with suppliers.

And don’t forget the carrying costs of inventory, such as storage, insurance, obsolescence, and pilferage. You can also improve margins by negotiating a net lease for your warehouse, installing antitheft devices, or opting for less expensive insurance coverage.

To cut your days-in-inventory ratio, compute product-by-product margins. You might stock more products with high margins and high demand — and less of everything else. Consider returning excessive supplies of slow-moving materials or products to your suppliers, whenever possible.

Product mix can be a delicate balance, however. It should be sufficiently broad and in tune with consumer needs. Before cutting back on inventory, you might need to negotiate speedier delivery from suppliers or give suppliers access to your perpetual inventory system. These precautionary measures can help prevent lost sales due to lean inventory.

Inventorying your inventory

Management often focuses on growth and puts inventory management on the back burner. This can be a costly mistake. Contact us for help researching industry benchmarks and calculating inventory ratios to help minimize the guesswork in managing your inventory.

External auditors spend a lot of time during fieldwork evaluating how businesses report work-in-progress (WIP) inventory. Here’s why this warrants special attention and how auditors evaluate whether WIP estimates seem reasonable.

Valuing WIP

Companies may report various categories of inventory on their balance sheets, depending on the nature of their operations. For companies that convert raw materials into finished goods, a key element is WIP inventory. This refers to partially finished products at various stages of completion. Management uses estimates to determine the value of WIP. In general, the more materials, labor, and overhead invested in WIP, the higher its value.

Most experienced managers use realistic estimates, but inexperienced or dishonest managers may inflate WIP values. This can make a company appear healthier than it really is by overstating the value of inventory at the end of the period and understating cost of goods sold during the current accounting period.

Accounting for costs

Companies assign costs to WIP depending on the type of products they produce. When a company produces large volumes of the same product, they allocate costs as they complete each phase of the production process. This is known as standard costing. For example, if a production process involves six steps, at the completion of step two the company might allocate one-third of their costs to the product.

On the other hand, when a company produces unique products — such as the construction of an office building or made-to-order parts — it typically uses a job costing system to allocate materials, labor, and overhead costs as incurred.

Auditing WIP

Financial statement auditors closely analyze how companies quantify and allocate their costs. Under standard costing, the WIP balance grows based on the number of steps completed in the production process. Therefore, auditors analyze the methods used to quantify a product’s standard costs, as well as how the company allocates the costs corresponding to each phase of the process.

With job costing, auditors analyze the process to allocate materials, labor and overhead to each job. In particular, auditors test to ensure that costs assigned to a particular product or projects correspond to that job.

Recognizing revenue

Auditors perform additional audit procedures to ensure that a company’s recognition of revenue complies with its accounting policies. Under standard costing, companies typically record inventory (including WIP) at cost, and then recognize revenue once they sell the products. For job costing, revenue recognition typically happens based on the percentage-of-completion or completed-contract method.

Get it right

Under both the standard and job costing methods, accounting for WIP affects the balance sheet and the income statement. Contact us if you need help reporting WIP. We can help you make reliable estimates based on your company’s specific production process.