With small businesses, resources are often in shortage. Reducing the time and effort you spend operationally on processes like accounting and financial management can help you save time and money in the long run. In an effort to save time and conserve resources, small business proprietors frequently overlook little things that can make a huge impact on their company. One such area is managing the business’ bookkeeping finances. If done right, it can give you the financial flexibility you need; done wrong and it can be a drain on the business operationally. Here are five common accounting mistakes that analysts make.
1. Using Generalized Financial Statements
If analysts take the time to actually read the finances, it is likely that they digest them through a third-party provider. The problem with this approach is that each of these services modifies each company’s unique financial statements to fit into a pre-created template. These services do this to ensure comparability across companies, industries, and nations.
2. Not Understanding the Reflexivity/Interactivity of the Three Major Financial Statements
Few analysts take the time to trace the dollar of capital raised within a company through the income statement to the bottom line and then back to the balance sheet again. Nor do they relate changes in the balance sheet accounts to the cash-flow statement to identify huge inconsistencies in either amounts or categorizations. Instead, most analysts investigate the statements in isolation from one another.
3. Not Creating Apples-to-Apples Comparisons in Time
This particular accounting secret is one that people rarely discuss publicly. Specifically, have you ever noticed that the temporal dimension of the income statement, balance sheet, and cash-flow statement are all altered? The income statement is stated quarterly for the first three quarters of the year and then annually, however, the balance sheet is always reported as a quarterly snapshot — even when it is the fourth quarter. Last, the cash-flow statement is always shown as an accretion of cumulative cash for the year. Each of these is very different from one another and they only align in the first quarter for any company. Companies usually play games with these time dimension mismatches. Consequently, analysts must put all of the financial statements on the same temporal dimension.
4. Not Adjusting Statements for Distortions
This is a classic problem in financial statement analysis. Despite this fact, most analysts do not amend financial statements to adjust for one-time items, including write-offs, sales of divisions, accounting revisions, and so forth. Precisely what to look for is outside the scope of this article, but most analysts simply do not take the time to do this. As a brief tip, if you ever see a write-off number that is a bit too round, such as $500 million or $75 million, you can bet that the amount is management’s estimate of a loss and not the actual loss. Consequently, you can expect future corrections to this initial write-off estimate.
5. Not Reading the Footnotes
Lastly, in spite of all of the warnings to pay attention to the information contained in footnotes, most analysts do not read them. Nor do most analysts take the numbers from the footnotes and put them into the main three bookkeeping financial statements.
An example of this would be to take the detailed property, plant, and equipment figures reported in the footnotes and incorporate these into the analysis of the entire balance sheet. It was once taught that a company was playing games with its useful expected lives figure because when looked at the common-size over assets financial ratios, it could see that one of their property, plant, and equipment numbers had gone down massively on a relative basis. This distortion, in turn, had big ramifications for the reported depreciation and hence net income, operating cash flow, and free cash flow.
While there are many other accounting mistakes that analysts can make, if you correct those highlighted above, it is believed that you will successfully separate yourself from your analyst peers and improve your returns.
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