For the last few weeks, we have been reviewing the simplified financial report from a non-accountant's perspective. I have tried to point out the key items a non-financial manager needs to know about in order to better understand his company’s performance. The financial managers are not usually responsible for how the company gets its products and sales. His duty is to report on how well you execute these activities for the owners and shareholders. Understanding this instrument is important for everyone in management. A complete financial report may well have many other details about which I have omitted discussion.
This financial data would have been part of the auditor’s report for the year-end 2008. The auditor is usually an outside accounting firm hired by the company to review its own accounting procedures. The auditor’s report follows a standard format. The first paragraph says what the auditor did. Namely, they state that the auditor has examined the books of Acme by following generally accepted auditing standards, which include tests (rather than 100% examination) of the accounting records. These tests might include sample inventory counts to confirm company reports and review of accounts receivable. I’ve known of companies that have been in trouble that will load up the receivables to provide a better balance sheet. We discussed this under white-collar crime several months ago.
The second paragraph gives the auditor’s opinion, based on the audit examinations performed. The key words in the opinion paragraph are “presented fairly” and “in conformity with generally accepted accounting procedures applied in a consistent basis.”
Additional paragraphs with words such as “subject to” or “except for” are used when the auditor has found deviations from these practices. These are red flags that need to be paid attention. CEO’s will fiercely fight the auditor over these additional paragraphs because they will not be well received by investors or banks. The leverage that the company may have over retaining that auditing firm has been known to occasionally impact the auditors report. Accounting firms have been sued and lost over improperly reported financial results.
Private companies in which all the shareholders are the managers may not generate audited financial reports if they have no bank borrowing. Obviously these may not be as reliable as an audited report. Owner/managers have been known to keep a separate set of books, which more honestly reflect the status of their company than that which they may show others.