Earn Money Reading Financial Statements

Business owners are in trouble. Income property owners, too. The demands of running a business or managing investment properties has reached an all-time high and banks are demanding more detailed financial statements than ever before. And therein lies a side gig opportunity with high income potential.

Every tax season my office sees hundreds of financial statements prepared by the client or their staff. You can’t imagine the mess most are in.

The client always thinks they are doing an awesome job of keeping their books. . . until they need a loan and the bank is less willing to decipher their books than the accountant.

The ability to read a financial statement is a powerful wealth building skill. You can detect fraud, analyse an investment and manage business liquidity. 

Banks will not spend time trying to figure out a mess. It is easier to pass. If the funding required is significant pristine records are not an option.

In short, reading a financial statement is a requirement for wealth building and business management. The financial statements tells you how the business is doing and the direction it is heading. Often, the financials will indicate problems before they are apparent in the real world. These festering problems are easier to fix when they are still small.

Reading financial statements are a good opportunity for you to generate extra income. It can even be a high-paying full-time business. Understanding how money works requires you to understand how money is recorded and that means financial statements. The number of business owners looking for help in securing a loan is a business opportunity that starts with the ability to read financial statements.

Buyers of a business are investing serious money and definitely need help understanding the value of the investment. Real estate buyers the same.

Accountants and attorneys are an obvious choice. However, many do not handle this kind of work. As a specialist, you can solve a business owner’s financing problems while earning an excellent income.

We will now review the three most common financial statements: the balance sheet, income statement and cash flow statement. The examples used are filled with errors I see in my office frequently. You can find more errors than I discuss as I added plenty.

By understanding common mistakes business owners make you can become familiar with the issues and become a value added service. Good financial statements (good records) are not an expense! Clients seeking help improving their records will be more profitable and therefore, a long-term client.

 

The Difference Between an Income Statement and the Balance Sheet

This may come as a surprise to you, but very few people know the difference between an income statement and a balance sheet. And don’t get me started on the cash flow statement.

I see clients recording entire loan payments as an expense on the income statement. For some reason they know loan proceeds are not income because they don’t want to be taxed on that money. However, when it comes time to pay the loan they think the whole payment is an expense (and deductible). It isn’t!

Loan proceeds go on the balance sheet, of course, as a long- and/or short-term liability. If you require detailed records for a business sale, purchase or bank loan, you will need to separate a loan into long-term (amounts due in over one year) and short-term (principle due in one year or less). If the business is small the owner may not want to separate the loan into long- and short-term. In those instances the loan should be recorded as a long-term liability. (The correct way is to list long- and short-term. In no way do I feel the shortcut of listing all loans as long-term acceptable.)

Loan payments have three entries in a general journal: cash out of checking (balance sheet), principle portion of the payment (balance sheet) and interest payment (income statement). As all accountants know, only the interest is an expense. 

If you can clean up this one issue you will save more businesses than you can imagine. If your client is making this mistake you may need to junk the entire set of books and start over. The books are a mess and in no condition for a banker or the tax accountant. (Tax accountants deal with this all the time and if the books are bad enough and the client unclear in explaining what they are doing, taxes can be wrong as well. If you give your tax accountant clean records she will save you money in taxes versus wasting time trying to ferret out what your numbers really are.)

 

QuickBooks Does Not Make You an Accountant

The biggest mistake business owners make is thinking QuickBooks makes them a good bookkeeper or accountant. This is about as true as saying TurboTax makes you a tax professional. If you believe that I have some cheap ocean front property to sell you in Montana.

The only thing QuickBooks lets you do is dig the hole faster unless you understand basic accounting. 

As we review the following financial statements you will see some of the crazy things tax professionals see every tax season: balance sheets with equipment and no accumulated depreciation and negative numbers where they don’t belong. (Yes, I know contra accounts happen. But negative petty cash?)

I gathered financial statement issues from multiple sources and introduced as many issues as I could in one set of financials. I started with a sample account QuickBooks provided in an older version to construct this monstrosity. I have seen worse unfortunately, but this will do for our needs. 

Do not focus only on the errors. Keep a keen eye on issues the financials expose. Getting the books in order before presenting to a bank is vital. Once the bank (or investors) start expressing concerns over the financials they start to lose confidence. Deal with the weaknesses of the financial statements before presenting. You still need to provide honest information and it must be clear. Having answers prepared in advance can make or break a deal.

The same rules apply from the other side. As a buyer of an income property or business you will be looking with the same jaundiced eye at the financials. If the books have errors it becomes difficult to trust the investment is solid.

 

Balance Sheet

You can click all financial statements in this post to open in a second, larger window.

Novices always want to start with the income statement. The income statement is too easily doctored to give a false picture. Assets and liabilities are the place you want to start, especially if concerned with the value of the business..

The above balance sheet has the head-scratcher of a negative petty cash account. In effect, this means the petty cash account is overdrawn. Someone will need to explain that one to me. 

The other account issues that make no sense is a negative loan to John Doe, a negative bank loan for equipment, negative accounts payable and receivable, and negative payroll taxes due. You might be amused by this, but half or more of all business financial statements I see each tax season have these types of errors.

To be fair, QuickBooks (QBs) is a disaster when it comes to payroll. Payroll taxes payable need to be adjusted periodically for some reason on the balance sheet. QBs even has a neat tool to make the adjustments. The rest of the payroll module is accurate, just the balance sheet has this slowly roaming error that needs periodic correction.

I’m not sure how you get a negative accounts receivable and payable. 

This balance sheet has too many loans to friends. Don’t loan money to your girlfriend from the business. Take a distribution (if allowed) and give a personal loan to your girlfriend. Better yet, don’t be your girlfriend’s banker. It never works. I see that in the office, too.

Under fixed assets we have office equipment listed without any accumulated depreciation. Land isn’t depreciated, just about everything else is. Was depreciation expense missed, too? Yup.

All these errors are the result of incorrect accounting entries. The loan to John Doe shows up as a liability because I treated it as paid from a payroll deduction. John is an employee. It takes fancy footwork to get the books this bad in QBs.

Financial records this bad are unsalvageable. You will need to start over. Fixing this mess would take more time than building a whole new QBs file. You could have a full-time business just setting up QBs files for businesses. If you never turned a client away you would have an army of employees hired to keep up. There is that much to do. Almost all records kept internally by the client are in need of attention. And if you think this balance sheet example is bad, you are wrong. This is typical. The only matter is the degree of issues involved.

I intentionally excluded the equity accounts to save time. 

 

Income Statement

You can click all financial statements in this post to open in a second, larger window.

There are plenty of concerns on the income statement, sometimes referred to as the profit & loss statement. 

There is a large amount of non-taxable revenue listed. This should be clarified and listed below sales for aesthetic reasons. I’m concerned this could be “other income” or a refund of some sort that should be listed under Other Income at the bottom of the statement or treated as an adjustment to an expense. 

Auto expense requires explaining. Was the IRS mileage rate or actual expenses used. If the mileage rate was used there is an opportunity to add the depreciation portion of the mileage rate back into income for lending purposes. (What condition is the vehicle log for tax purposes? Were personal miles mixed in?)

Contributions were really donations to charity. Sometimes a business can deduct donations as a sponsorship. Personal donations to church are not a business expense and should not come from the business account. 

Miscellaneous expenses are high and need to be accurately classified. 

Payroll and payroll expenses should utilize sub accounts. The officer’s wage looks fine (if this is an S corporation) compared to net income, but the type of business may change that determination. Removing contributions and a few other items from the expense column could leave the reasonable owner’s wage requirement a bit light (for corporations only).

The SEP/IRA is a concern. Is this a retirement account run through payroll or an IRA contribution for an owner paid out of business funds? It needs to be cleaned up or clarified. Payroll with sub accounts would be ideal to address the lack of clarity.

The business portion of Social Security is listed, but is the wrong percentage. The Social Security portion of FICA is 12.4%; half paid by the employee, half by the employer. The Social Security expense of $5,562.26 is more than 10% of the officer’s wage of $53,800. The employer’s portion is only 6.2% and there are no other wages listed on the income statement!

Payroll expenses are listed as $18,909.25. Is this employee wages? It would explain the FICA issue. This would need to be cleaned up/clarified before presenting to a bank or buyers.

Finally, utilities are not an “other expense”. This needs to be moved up with the regular expenses. The sales tax adjustment also needs addressing.

 

Cash Flow Statement

You can click all financial statements in this post to open in a second, larger window.

The cash flow statement is my favorite. I want to see where the money is coming in and going out. This includes loan proceeds and retirement of debt. If the statement is accurate it can tell you a lot about the health of a company. As you can see, this is not an ordinary business.

If the balance sheet and income statement were clean I would have confidence in this cash flow statement. However. . . 

We discussed several issues on the income statement and balance sheet which reflect here. The item I want to point out is the shareholder distributions. Added to the officer’s wage, we get the total cash the owner received from the enterprise in 2018. 

Even with terrible books we are still able to get a vague idea how much the business is disbursing to the owner. The odds are pretty good the owner received a $53,800 wage and $35,950 in distributions. Cash was negative at the beginning of the period (unbelievable) and around $34,000 higher at year-end (believable if the rest of the books were not a mess). Messy books means the business probably throws off close to $90,000 in cash to the owner, more if contributions are not really a business expense. If the books were clean we could add the $34,000 increase in cash for the year since I don’t see any lending activity.

 

Analysis and Opportunity

Obviously this was an extraordinary mess used to illustrate multiple recordkeeping issues. Many businesses have books this bad, if they have any records at all. A thriving business can fail due to mismanagement of recordkeeping. Poor records can cause a business to over-pay taxes, lose bank funding and result in a lower sale price of the business at the end of the owner’s career.

Warren Buffett has said many times Accounting classes were the most important he attended in college. I agree. Without a fundamental knowledge of accounting it is difficult to build serious wealth and almost impossible to run a successful business. With a sound understanding of accounting and financial statements you are qualified to manage most businesses and investments, including finding the true value of the asset.

You don’t have to be a banker or financial analyst to use financial statements. Investing in a stock is investing in a company and should be treated the same way as buying an entire smaller local firm. Buying income property successfully requires understanding financial statements to make a sound decision. You want to know the rent history and expenses, plus required deferred maintenance, before making a decision to buy or pass.

Since most roofers are good at roofing and poor at keeping accurate records, you have a powerful side gig opportunity to make a difference in your community while earning above average income. 

All business eventually need funding. Your ability to read financial statements allows you to consult with clients at a higher level and to gain desired result. You can handle the raw data entry if you want or farm it out to a bookkeeper. Regardless, you lead and give directions. 

Done right, you and your clients will profit.

 

Coda

So how can you start reading financial statements as a side gig or person use if you don’t know how already? You could always take a college or technical school course. Or, you can self-study. Here is a good book to get you started. It will cover 99% of what most people will ever need. Note you will still look things up from time to time. It is the nature of the skill. The linked book is a good reference source. 

 

 

More Wealth Building Resources

Personal Capital is an incredible tool to manage all your investments in one place. You can watch your net worth grow as you reach toward financial independence and beyond. Did I mention Personal Capital is free?

Side Hustle Selling tradelines yields a high return compared to time invested, as much as $1,000 per hour. The tradeline company I use is Tradeline Supply Company. Let Darren know you are from The Wealthy Accountant. Call 888-844-8910, email Darren@TradelineSupply.com or read my review.

Medi-Share is a low cost way to manage health care costs. As health insurance premiums continue to sky rocket, there is an alternative preserving the wealth of families all over America. Here is my review of Medi-Share and additional resources to bring health care under control in your household.

QuickBooks is a daily part of life in my office. Managing a business requires accurate books without wasting time. QuickBooks is an excellent tool for managing your business, rental properties, side hustle and personal finances.

cost segregation study can reduce taxes $100,000 for income property owners. Here is my review of how cost segregation studies work and how to get one yourself.

Worthy Financial offers a flat 5% on their investment. You can read my review here. 

Keith Taxguy

13 Comments

  1. George Wood on February 4, 2020 at 11:39 pm

    Great article Keith! I have seen many financial statements worse than this. One of my favorites was a client who had put all of his assets on the books at $0 and increased their value every time he made a payment, debit asset credit cash, the really fun part was the argument from the owner that he was doing it right because he owned more of the asset with every payment. Of course he didn’t have an answer when I asked him how we got the loans off the books! We didn’t work together long as that was not even the major problem. Clean financial statements are such a boon to a business and I love working with owners that recognize this.

    • Keith Taxguy on February 5, 2020 at 9:41 am

      You hit a key point, George. Not every business owner understands the value of clean financial statements. They are not your clients. You don’t want them because they will never engage at a level where value is created. Now the business owners who do get it are what I live for. Value creation almost looks like magic it works so well.

  2. bpo_ben on February 5, 2020 at 12:55 am

    This blog post is spot on! As a Fiverr side hustle I help acquirers of businesses, who are presented with quite limited financials by brokers.

  3. Brad on February 5, 2020 at 10:02 am

    So could you add some suggestions on titles, websites, etc. that you would point towards in building a good foundation on understanding accounting outside of taking university courses?

    • Keith Taxguy on February 5, 2020 at 10:53 am

      You don’t need a college course to learn financial statements. Here is a book you can start with. It will cover 99% of what most people will ever need and you can look that up when the time comes.

  4. Sarah Cutchin on February 5, 2020 at 12:32 pm

    I keep looking for a niche in the business/accounting world without having to commit to classes . This is promising! Excited to rent the book!
    Any recommendations on where to find clients once we’ve got a good foundation? Flexjobs? Fiverr? LinkedIn? Is there somewhere business owners go to look for help?

    • Keith Taxguy on February 5, 2020 at 1:00 pm

      You can try those resources for new clients. A better choice might be to start with a few presentations at the local Chamber of Commerce or apartment association. Eagles, Elks, Optimist Club and similar organizations are always looking for speakers with 15 minute presentations. The key is to get those first clients so word of mouth does the rest. Local social media pages might also have opportunities. Tell people what you do where ever you are normally in life. An excited disclosure you help help people clean up their financial statements so they can get a bank loan or sell their business for more at the gym can yield results. Once the ball starts rolling I think you will find repeat business and word of mouth will keep you busier than you want. At least that has been my experience my entire career.

  5. J on February 5, 2020 at 2:37 pm

    One side note on this type of work. If you are a licensed CPA you need to become familiar with the rules of your State Board of Accountancy. Some of the types of engagements above could be considered “compilations of financial statements” or could become a “review of financial statements” engagement. There are often state rules around how this work is done, whether or not you may need to register as a firm, and whether or not your engagement in the services above require you to undergo a peer review. Some of the services above now require an official engagement letter in certain states (as opposed to just suggesting one), and there can be rules over the handling of a clients records in the event the job is terminated for any reason (example, you can’t keep client records just because they didn’t pay you, but you can keep your own prepared files or reports). The repercussions for not knowing these rules and/or not following them can be quite severe. In NC I’ve seen everything from $1000+ fines, censorship, temporary license suspensions, permanent license suspensions or a combination of the latter. NC also sends out a “naughty list” to all CPA’s each month with all the disciplinary actions they took and against what individual CPA or CPA firm. But if you’ve made it through all that and feel good about doing that work, then I would imagine you can charge even more for being a CPA. I vaguely remember the hourly rate the CPA firm I worked for many years ago charged for me as a Senior Auditor, and I only wish I made even half of that rate on my own!

    • Keith Taxguy on February 5, 2020 at 3:02 pm

      Excellent points, J. In my office we only do unaudited compilations. CPAs are licensed at the state level and the rules are different between states.

  6. Lee on February 10, 2020 at 9:20 am

    How do you find the business? I’ve been doing this kind of work as a full time employee for mid sized companies in the “city” for years. I’d love to do this sort of thing in a smaller town or more rural area, but have never known where to start.

    • Keith Taxguy on February 10, 2020 at 9:47 am

      City or rural, it is all the same, Lee. Speak to local groups (Elks, Eagles, Chamber of Commerce, etc.). Small communities are even better than cities because the social network is tighter. In a small community I would also talk with the lenders; they might also be a source of new clients. Promotion does not have to cost much (the cost of driving to see folks).

      I also published a post on this some time ago you might find of value. If you are interactive with people you will be busier than you can handle very fast, regardless the economy.

      • Lee on February 11, 2020 at 1:08 pm

        Thanks! Any thoughts on whether a CPA or other designation would help with this? I haven’t relocated back to my small town (in MN) yet, but would plan to in about 4 years. I’m wondering what I could do to set myself up better for this in the future.

        • Keith Taxguy on February 11, 2020 at 1:21 pm

          Professional designations can add credibility. In some instances a CPA is required (example: audited results, SBA loans). Note that CPAs are licensed at the state level and may have some obligations related to this type of side gig such as reporting to the accountancy board on your business activities.

Leave a Comment