How Do You Review Financial Statements? (Part 1)

I am breaking this topic into three and in this article, I am covering one of the financial reports which is the Balance Sheet.?

If you sit on a board or are presented with a set of financial accounts, how do you review them?

I am not going to pretend that I can cover everything in this short article but at least give you some pointers and maybe arm you with some questions.

However, I must stress a fundamental principle of reviewing financial statements. You need to understand the business. Different business structures or industries look totally different and will have different financial challenges, KPIs, pain points and therefore should have different financial strategies. Do you understand these for the business?

I am going to assume that you know your way around the 3 key financial statements, shown in the graphic – their purpose and what each of them shows. (If not, please do reach out, you are not alone and we can help you with this).

So let’s look at areas you might examine on the Balance Sheet:

When reading a Balance Sheet, we recommend that you focus on the following:

Analysis of assets

• What evidence is there around the collectability of accounts receivable (i.e. will the amount shown actually be received);
• Do you know the difference between the market value of securities/investments and their recorded cost?
• Question if inventory on hand is saleable in the foreseeable future;
• Are you satisfied that all significant capital assets of the company are recorded on the balance sheet?
• Have you had discussions re whether the company plans to or needs to replace capital assets in the future? Are non-current assets on the increase?
• Read the notes to the financial statements to determine the detail re accounting policies, the treatment of revenue, depreciation rates, right of use assets etc.

Analysis of liabilities

• Compare current liabilities with current assets. The company should have sufficient current assets (the sum of cash, inventory, accounts receivable, etc.) to cover its current liabilities. If it does not, then you should question how the company will pay the amounts owing in the upcoming year. (Refer to the cash flow forecast, an internal document, which should be giving you reassurance on this point).
• Review the terms and conditions of loans and other debt to determine whether any large payments are due in the near future.??
• Read the notes to the financial statements to determine whether there are any potential liabilities that could not be quantified as at the year end.

In Part 2, I will look at the Profit and Loss Account Report or Income Statement. If you would like to read the full article, it is posted on our website https://www.financialtrainingaustralia.com/blog

If you would like any extra help, you can always give us a ring (+61 3 413 942 803) or drop me an email at [email protected].