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The Risks of Misinterpreting Your Financial Statements

Posted on October 7th, 2018

Jack Kern
Owner, President
Outsourced Accounting Department, Inc.

Many small business owners I’ve known view their financial statements as something that is only needed for tax purposes. However, to ignore or misinterpret what your financial statements are telling you, and then not utilize that information to forecast where your business is headed, can be a recipe for major disappointments, or worse, a future financial disaster.

I have written numerous articles that touch on this topic in one way or another. Here “in a nutshell” are the financial risks that you could be exposing your business to:

  • Loan Application Declined – You get turned down for a business loan because your tax return is showing a “loss,” when your business is actually profitable. (See topics on “accrual vs. cash basis accounting,” and “establishing lender relationships”).
  • Taxable Income vs. Operating Losses – Your tax return indicates you are making a “profit,” but your business is actually losing money. As sales decline, cash flow may temporarily increase due to declining accounts receivable and inventory.  But eventually, all of your cash is drained out of the business due to the underlying losses until it, and maybe you, are bankrupt. (See topics on “accrual vs. cash basis accounting,” “profit vs. cash flow,” and “turnover ratios”).
  • Past Due Loan Payments – You’re defaulting on loan payments even though your tax return is showing a profit. (See topics on “accrual vs. cash basis accounting,” “loan repayment,” “cash flow,” and “income vs. cash flow”).
  • Profit but No Cash– Your financial statements are showing a profit, but your checkbook doesn’t reflect that and you’re running out of cash.  Possible causes are rapid sales growth, or your receivable collections, inventory purchases, or accounts payable, are poorly managed, or sources and uses of funds are not properly matched. (See topics on “sales growth,” “sales concentrations,” “turnover ratios,” “cash management,” “asset-based borrowing availability,” and “matching of sources and uses of funds.”)
  • Inability to Sell the Business – Over the years, you’ve done a great job of minimizing (or avoiding?) taxes. But then when you’re ready to retire, on paper, your business isn’t worth anything in the eyes of prospective buyers. (See topics on “exit strategies,” “accrual vs. cash basis accounting,” “financial planning” and “budgeting.”)

Related Articles:

For more information on these topics, browse our blog articles (including in the archives off to the right) in our website at www.kernaccounting.com.  To better understand the difference between our firm and other accounting and bookkeeping firms, view these articles specifically:

The Difference Between Your CPA and a Controller: M-1

Why Outsource Your Bookkeeping?

 The Opportunity Cost of Being Your Own Bookkeeper


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