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Reading Financial Statements for Profit

How to give a powerful speech or presentation. Move the crowd. Create engagement and interest. Get more sales. Turn your speaking gig into profits. #speech #sales #motivation #engagement #presentation #speaking #publicspeaking #profitLast Monday I attended a one day seminar on Reading Financial Statements. While I am not a CPA, I am an enrolled agent (tax professional). Working in business my entire adult life in the tax field means I have a working knowledge of financial statements. I also took accounting, business and economics courses in college.

Having a strong background does not always mean you are good at it. Sometimes we fall into bad habits or forget some of the more esoteric details of the craft. My hope was to learn at least one new insight into reviewing financial statements that would give me a better or clearer view of the report.  

Financial statements are the lifeblood of business and investing. Running an efficient company requires solid recordkeeping and the ability to understand what basic financial reports tell us. Without a firm understanding of the financial reports you are guessing when making important decisions in your company. 

The same applies to investing. Warren Buffett said that accounting is the most important class he took in college. Buffett feels business classes are important, but accounting gives you the knowledge you need to run virtually any business. A firm understanding of financial reports means you understand details about the firm. You don’t need a world class business school to acquire a firm grasp of accounting. A local tech school or extension college is just as valuable.

Even in personal finance financial reports are important. If you don’t understand your own financial condition (the balance sheet) you are at risk or serious financial error and loss. The same can be said if you don’t understand where the money is all going (cash flow statement). Tracking your income and expenses (income statement) is a powerful tool for building wealth. Guessing is not a substitute for knowledge when money is involved.

 

Train Wreck

Last Monday promised to be a day of review with a few additional insights. The promise took a left turn quickly.

I was the first to arrive at the class. (I am like that; teacher’s pet, showing up early.) About 20 students filled the room. Kimberly, a fine young lady from Florida, was our instructor.

From the beginning she looked nervous. I was quiet, yet attentive as she struggled to deliver the message. 

A small class of 20 student should not shake a speaker. At first I thought she might have personal issues or feel ill. 

Then she interspersed light comedy pieces between sections. They didn’t match the curriculum and were very out of place.

 She decided not to follow the workbook, instead, using a PowerPoint of her own design as her teaching tool. 

There were several glaring errors. At one point she had the accounting equation on the screen and proceeded to  explain how the equation worked on the balance sheet. This is what her slide showed:

Asset=Liabilities-Owner’s Equity

Can you see the problem? The formula is really:

Assets=Liabilities+Owner’s Equity

Some people call Owner’s Equity Capital or just Equity. The point is that liabilities and equity are added, not subtracted, to equal assets.

Kimberly went on to explain why her equation was how accounting worked. Nothing added up. Something was very wrong!

I bit my tongue. It isn’t my place to embarrass her. However, it did bother me the other students were getting bad information. Some of the other students were drinking it in because they really didn’t know the right answer.

 

Some Education is Better than None

By mid-morning it was painfully obvious Kimberly was in over her head. Situations like the formula above and statements like, “accounts payable should never exceed accounts receivable” were blatantly false. 

The course provider (name withheld to protect the innocent) had a workbook we did not use. By going off on her own PowerPoint Kimberly was reinventing the wheel. I still has not put the pieces together as to what was really wrong with our speaker. She has 17 years experience in bookkeeping. You don’t survive that long (and get hired to teach a course) if you are that bad at it.

The few questions asked by the class I answered. To help the group move in a more appropriate (and hopefully more accurate) direction I asked a few questions and guided the responses. I decided to gently mention accounts payable (AP) can, and in many instances should, be higher than accounts receivable (AR).

It was time to drop a golden nugget to return interest to the class. I went back to an earlier discussion on cash versus accrual accounting and asked: When should a small business use accrual accounting instead of cash accounting?

The room looked like a herd of deer in the headlights. Small businesses can use cash accounting for taxes by default. You can elect to use accrual if you choose. (The upcoming Halloween post on  Financial Horror Stories II includes a story where a client made a big time mistake I fixed by understanding why accrual accounting can be a powerful tool. Be sure read it.) 

Most small businesses have an accounts receivable. Not all, but a large percentage do. If your receivables are larger than payables you want to remain on cash accounting, especially for taxes. However, if your AP tend to always be larger than your AR you will want to consider accrual accounting. 

The reason for this is clear. If AR are larger you don’t want to pay tax on money not yet received so cash accounting is better. If AP is larger you can deduct the expense before it is paid under accrual. 

With this it was time for lunch (fifteen minutes early). Thank God.

 

Time for a Break

Kimberly did not join us for lunch. As some of the students ate together we talked. One student was a retired CPA from a large CPA firm. He was not happy.

I admit I expressed concerns over lunch. It is my policy to never denigrate another person pouring out their soul to a group. I am by no means always innocent myself. In this instance I was reasonably true to my policy, and as will soon become clear, I am glad I was.

A third of the class never returned from lunch. Kimberly looked worse than in the morning. 

From what I gathered, she ran out of material in the morning.

The afternoon session was worse than the morning. We returned from lunch at 1:00 and by 1:30 it was getting ugly. The material was all over the map and did not make sense. Most was a glossing over of the morning material. 

Either I had to take action or the class would be over on the spot.  

I interjected, “I read the workbook over the weekend and would like to review some of the material there.” 

Everyone, including Kimberly, was happy for me to provide some direction. 

“On page 32 of the workbook there is an income statement. What is wrong with it?”

A good discussion on fraud prevention ensued. In a short period of time I was able to pry from the financial statements many details of the company presented.

What glaring problem do you see with this balance sheet?

What glaring problem do you see with this balance sheet? I’ll answer in the comments in a few days after publication. Hint: The company is in trouble.

I will not give a play-by-play of the remainder of the afternoon. What I will say is the discussion picked up and for the few that remained for the afternoon we had a good discussion with value.

Class ended early.

 

The End was the Beginning

When the curtain came down the remaining students left. Many grabbed my card (I didn’t bring my business card so I handed out my card for this blog).

The first to arrive I was to be the last to walk out with another student, a retired teacher.

Kimberly walked behind us and said, “Thank you for asking questions and moving the class forward.”

I replied it was no problem. I mentioned I could tell something was wrong.

“This is my first class,” Kimberly said. She was nearly in tears. It was a long, hard day for her.

The pieces all fell into place. 

“I can’t understand what went wrong,” Kimberly continued. “I spent two weeks planning this class and practiced.”

The school teacher and I stayed for about an hour helping Kimberly improve her game and good thing. Kimberly was headed back to Illinois for two more presentations of the same program before heading home. The reviews from today’s class were brutal. If she didn’t make a comeback she was at serious risk of losing her job.

I recommended she dump the PowerPoint. The school teacher said she might want to use a meme.

I gave an example of how I would conduct the class: Use the workbook, ask students questions, get the students thinking. Tell stories. Engage the class. Find the reason they came and work it. 

Kimberly recorded some of my remarks on her phone for review as she drove back to Illinois. She wanted to listen to it again and again. In less than an hour I outlined how I would conduct the class. It would be impossible to finish it all in a day. That makes for a good, fast-paced class.

Mostly, I told Kimberly, she needed to have confidence. She has almost 20 years experience as a bookkeeper. Yes, she is not a CPA, but she is very familiar with financial statements. There is plenty of material to engage and peak the interest of any group. Focus on what is relevant to the attendees. Each presentation, as a result, will be slightly different.

Kimberly looked very tired when we left. She also looked like she had hope. The company had a workbook with plenty of material to easily fill a day. Mixing in personal stories would keep the group awake and engaged. 

 

For the Sake of One

I made it clear to Kimberly she had nothing to lose. It is unlikely she will ever see any of these students again in her life. Just give the best darn presentation you possibly can, I suggested. Give a piece of you. Make it real. Go in with the goal of helping everyone present learn at least one new thing this day.

The knowledge doesn’t have to come from you, I continued. You would be surprised how often the best insights come from other students as they ask questions and debate answers. 

As I said to Kimberly, it is unlikely we will ever cross paths again. There is nothing to lose. Nothing to be embarrassed about. This was not about personal gain; it was about paying-it-forward. It is the only thing that gives life meaning; helping others find meaning in their’s.

Kimberly did not contact me afterwards. I have no idea how it turned out in the Illinois classes. 

Steve Jobs asked John Sculley if he wanted to change the world. Well, I haven’t changed the world at the level of Steve Jobs.

But I may have changed the world for one. And it was worth the effort.

 

 

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Keith Taxguy

11 Comments

  1. Mr. Hobo Millionaire on October 7, 2019 at 6:11 pm

    I’ll take a stab at the Balance Sheet. The big thing that jumped out at me is there is not enough Cash and A/R coming in (cash flow) to handle all of the liabilities. It’s barely enough to cover A/P with nothing left over for payroll and taxes. The company might be able to dump inventory to raise some cash, but then you have nothing left to sell. Yes, the company is in deep doo.

    Assuming they can sell the land and building quick enough, I’d do that, pay off the debt including the loan, and lease a location (maybe even lease same location back from buyer). Doing quick math, they’d have about 1.2-1.5M left over in Cash to continue and cover payroll.

    • Keith Taxguy on October 10, 2019 at 12:09 pm

      I think we have a winner, MHB.

      What jumps out at me immediately with this balance sheet is that the company is within 2 weeks of bankruptcy. Salaries and Wages Payable exceed Cash and Marketable Securities so to make payroll, which is usually due within 2 weeks unless they have monthly or other payroll period.

      There are many issues with this financial statement. Stephen (above comment) mentioned prepaid insurance. Perhaps if they got a quick refund on the over payment they might make payroll. The bank loan also looks high. If you saw the accompanying P&L you would really think the loan balance is high.

      We could spend a day carving up this balance sheet. Instead, I hope I whet your senses to dig deeper into financial statements to glean information about the company. This is helpful in running your own firm and imperative if you are considering an investment.

  2. Karl on October 9, 2019 at 5:17 pm

    Well done, Keith. Way to address the source of the problem than attack the symptoms. Hopefully this instructor takes your words to heart.

  3. Stephen Jensen on October 9, 2019 at 10:09 pm

    Prepaid insurance $400k. They paid up like 50-100 years in advance or have some serious misappropriation of assets, or serious incompetence of the bookkeeper??

    • Keith Taxguy on October 10, 2019 at 11:49 am

      That was a secondary issue. See comment I made on Mr Hobo Millionaire’s comment for full details.

  4. Andrew on October 12, 2019 at 4:45 am

    What I remember most from accounting classes is that balance statements don’t tell the whole story and can be manipulated. We need to see the various cash flows to detect fraud as cash flows cannot be easily manipulated.

    I’m a newer reader of your blog and love the content. It’s great that you enjoy your work so much and that gives you great results. I hope your health will get better. Thanks for writing

    • Keith Taxguy on October 12, 2019 at 8:16 am

      Andrew, in the class we discussed the details you mention. The P&L and cash flow statements were available as well. My comment to the class was that the cash flow statement is the hardest to cook so I tend to drift that direction fast when reviewing financials. I didn’t include everything in this post due to copyright issues and to keep the post manageable in length.

      Thank you for the kind comments. My health has improved. feeling better I increased my workload which I am feeling. Now the focus in on finding the right balance.

      • Bob on October 15, 2019 at 10:05 am

        Interesting you mention cashflow statements to uncover fraud or basically show a true picture as to whether there is any real cash in the business. My 2 favourite ways that people can still hide stuff in the cashflow statement is by redefining the meaning of cash with cash equivalents, and by messing around with capex and selling you an undermaintained business to boost cashflow.

        The worst fraud is the stuff of Enron / Steinhoff where you hide / change transactions between subsidiaries that are from different auditors, and management and accountants thus collude to defraud shareholders.. That and recent chamges to ifrs for fair value accounting is making me hugely discount the listed share prices because you cannot see an accurate picture anymore. At least in your line of work most businesses are still real operating companies and cash flow is generally cashflow.

        • Keith Taxguy on October 15, 2019 at 10:11 am

          I didn’t say it was impossible, Bob. If someone is intent on committing fraud they can bury stuff on any financial statement. It is harder to hide malfeasance on the cash flow statement, not impossible. Accounting fraud is always the hardest to detect. Financial statements uncover fraud outside owners best. It takes real sleuthing if insiders are in on the job.

  5. Edward on October 23, 2019 at 3:00 pm

    Keith,

    A somewhat random question, but in your article you said – “ Tracking your income and expenses (income statement) is a powerful tool for building wealth. Guessing is not a substitute for knowledge when money is involved.”

    On a foundational/personal level this starts with our own income and spending habits. Do you favor a method or software for tracking personal income and expenses? If you have strong thoughts on this, perhaps it could be a future article?

    I appreciate all the knowledge you share here.

    Thank you,
    Edward

    • Keith Taxguy on October 23, 2019 at 3:48 pm

      My strong thoughts are on recording your finances, Edward. The method you use is the one you stick with. I used paper and pen for decades, moved to Excel worksheets and still do for personal while using QuickBooks for business. Bells and whistles do not impress me. Do what works for you.

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