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Elements of a Financial Statement

August 24, 2017

Publicly traded companies are required to issue audited financial statements annually. There are seven parts of the statements that are briefly described here in the usual order they are presented:

  1. Report of independent registered public accounting firm. This provides their opinion that the financial statements were in conformity with U.S. generally accepted accounting principles [GAAP]; that the company maintained effective internal controls; that the audits were conducted in accordance with standards of the U.S. Public Company Accounting Oversight Board [PCAOB] and some other things and that their audits provided a reasonable basis for their opinion; and that the internal control may not prevent or detect fraud. This needs careful reading and understanding, as do all seven elements of the statement, but on some level this type of report is the gold standard for public companies.
  2. A balance sheet or statement of financial position shows snapshots of the company’s assets, liabilities and stockholders’ equity as at the end of the fiscal year. Usually the current year is compared to one or two previous years. The “balance” is that the assets equal the liabilities plus the stockholders’ equity. The stockholders’ equity is usually referred to as the book value or net worth per the books.
  3. A statement of earnings or income provides a summary of the annual operations of the company. It shows the gross revenues, total costs and expenses and net income. If the balance sheet is referred to as a snapshot, the income statement can be referred to as motion picture with a beginning, middle and end summarized for the year.
  4. The statement of cash flows shows how much cash came into or left the company during the year in three categories – from operating, investing and financing activities. While the balance sheet shows the year end balances, and the statement of operations the total activities of the company during the year, this statement relates everything that occurred to either cash in or out.
  5. Other comprehensive income reports on items not considered as income or loss or capital transactions but that affect the company’s net worth. Examples are foreign currency translation fluctuations, gains or losses on securities invested in that are not intended to be held long term or certain adjustments to retirement plans.
  6. The statement of changes in stockholders’ equity reconciles the beginning of year amounts with the ending taking into account the income earned or lost, sales or repurchases of capital stock, dividends paid, and other actions affecting stockholders’ equity that did not appear as separate items on the other statements.
  7. The notes to financial statements contain disclosures explaining the amounts reported on the five statements where there are choices as to how they can be reported. The notes also explain which generally accepted accounting principles (GAAP) the company has adopted. For instance there are numerous ways depreciation can be calculated and inventory valued under GAAP. The notes are not “footnotes” but an extremely important and integral part of the financial statement. Some companies have more than fifty pages of such notes and each should be read and understood when financial statements are reviewed and analyzed.

The is a lot more to financial statements, but the above is a good way of starting to understand their organization and contents.

Benefits from an Audited Financial Statement

August 22, 2017

One of my clients generously gave me his take on the benefits he received from the audited financial statements we issued for him. I was appreciative of this and want to share his views with you.

He began with an introduction explaining how he started his business and shepherded its growth by concentrating on developing his services and delivering them quickly and on time to his clients. The business grew rapidly and little time was spent on the record keeping except for getting invoices to the clients, and making payroll while keeping the back office as lean as he could. At the same time there were legal, regulatory, HR, occupancy and tax issues from operating in multiple states and countries and he was spending quite a lot of time and fees on these activities, because he had to, while pushing aside and neglecting the accounting work.

Because of his company’s success, a dire need developed for additional capital and no one would speak to him without the appropriate financial statements. That is when he reached out to us. We assessed the situation, developed a plan and time table and sent in a team to organize his system and get him what he needed. We did and he reaped the expected benefits. The benefits also came because of his business model, client base and delivery of his services.

He told me about the many users of his financial statement and how it helped him.

  • Management: He and his management group now had credible information about the operations and their financial position. In addition to the basic financial statements there were many supporting and ancillary schedules and analyses that helped them in managing the business and creating usable budgets and projected statements including a reasonable five year forecast that served as a viable benchmark for targeted goals.
  • Early Stage Investors now had reports on how their funds were used and where the company stood.
  • Prospective investors were able to assess the current operations and developing trends and along with the projections they were able to take positions in the company providing needed funds for growth. The financial statement was also useful in establishing a beginning point for valuing the business.
  • Employees gained comfort that the company had a clear direction where it was headed.
  • The Board of Directors were given materials they were able to use to better advise management and were able to be much more effective. The time they previously spent chastising management for the lack of reliable financials and current information was converted to time better spent on positive guidance. The financial statement also provided insights that the company’s resources were being used wisely.
  • Customers were assured that the company was on a solid ground to be able to continue the great service they have become accustomed to and were relying on.
  • Suppliers are creditors. Some were provided with the financial statement to support increased credit limits and assurance that the company had the ability to pay its bills on time.
  • Bankers were not previously providing any funding because of the lack of financial statements. They were now able to participate reducing the need to give up equity to investors for those funds.
  • The accountants were better able to provide tax strategies that increased cash flow and to provide additional services that tightened controls, improved systems and to have delivered timely and more relevant financial data.
  • Government regulatory bodies in this client’s case do not receive audited financial statements to determine if the company is operating within prescribed guidelines. However, we explained that while taxing agencies typically do not receive audited reports they could be helpful in income tax audits should one arise.

Financial accountability mattered. Besides the above benefits it provided a broader landscape, greater controls and more effective procedures, and set in motion a pattern of solutions based recognition. It also put the company in a position to attract key personnel, possible merger candidates, a presentation to potential acquirers [which they were not considering but kept the door open to dialogues], companies they could collaborate with, technology and marketing consultants who could suggest systems that could move the company forward, and a strategy to achieve better client service, organic growth and customer referrals.

He called us in because he needed the reports and got so much more; he got control over his company. Audited statements do matter and provide benefits far more extensive than what appears from the 25 or 30 page report. If you are a growing business, discuss with your accountant the advisability of an audit.

Sam Zell’s parents’ story

August 17, 2017

My interests are varied, but sometimes my focus is too narrow. It happened with this book and I was embarrassed about it. Here is what happened.

When I told Rick I finished Sam Zell’s book he asked me if I ever heard of Sugihara and I did not know what he meant. I had to reread the first chapter to engrave the name in my mind and to fully appreciate who Sugihara was and the great thing he did.

Zell’s parents escaped from Poland at the onset of the Nazi invasion and went on a circuitous route until they arrived in the United States. In order to get here they needed to get out of Europe. They were able to get to Vilnius, Lithuania and were then able to get forged entrance visas for Curacao but had to travel through Russia and Japan, a journey of 8,000 miles. To do this they needed a travel visa for Japan.

A Jewish refugee delegation went to the Vilnius Japanese vice consul, Chiune Sugihara, for those visas. Sugihara’s instructions when he wired Tokyo was to deny permission. Risking his career and causing danger to his family he took it upon himself to issue enough visas so that 6,000 Jews were saved. This wasn’t widely known after the war, but in 1985 Sugihara received official recognition in Israel as a Righteous Gentile by the Yad Vashem, the Holocaust Martyrs’ and Heroes’ Remembrance Authority. Sugihara’s courageous actions became his legacy – he made a difference!

Sam was born four months after his parents arrived in the United States. Zell’s parent’s story leaving Europe and the certainty of being murdered there and coming to America with very little and not able to speak the language and then forging a successful life is remarkable. That experience has been replicated many times over, though not as much as it could have because of America’s restrictive immigration policies during the period of the Nazi murders of European Jews. To learn a little about one family’s situation, read the first chapter of this book.

Do you want a recognize an entrepreneur in your network? Withum is currently accepting nominations for our Entrepreneurial Strength Award! Using social media, simply nominate an entrepreneur and use #StrengthStory and tag @withumcpa! A member of our team will follow up with you for more details. Nominations are due August 22! For additional information, please visit https://www.withum.com/strengthstory

Am I Being Too Subtle? By Sam Zell

August 15, 2017

Sam Zell’s autobiography, “Am I Being Too Subtle?” is a must read for anyone that is involved in real estate investing, business acquisitions or who wants to become an entrepreneur.

The book was recommended by my son Rick who is a stock trader and when I finished it I asked him why he read it. He told me that Sam is a very wealthy deal maker with many opinions he agrees with, so he thought he would enjoy the book, which he did. I read it because Rick loaned it to me. I could not put it down and highly recommend it.

I have my own interests, just as Rick has his and everyone else, theirs. I particularly liked the entrepreneurial aspects Zell wrote about and want to share some of his principles.

  • Sam’s fundamentals of business are understanding supply and demand, that liquidity equals value, and good corporate governance and reliable partners are essential
  • Be grounded and pragmatic, recognize a sense of responsibility, and have a shem tov
  • Shem tov is a Yiddish expression that means to have a good name – be a man of your word, do what’s right, do not lie – be a mensch
  • Where there are partners, transparency and the alignment of interests are absolutes
  • When there is scarcity, price is no object
  • Basic tenets of business risk: A big downside and small upside should be avoided. Look for a big upside and small downside
  • Zell refers to William Zeckendorf’s autobiography where Zeckendorf viewed assets as a sum of parts where the value of the whole could be increased using various parts that would be more valuable to different buyers
  • Entrepreneurs need vision, direction, strategy, confidence, optimism, conviction, courage, initiative and creativity and then they need to do something. Without execution, nothing happens

There are many more gems and to get the full flavor of them and everything else he wrote about and Sam’s sagacity, please read the book.

Books are rated highly by me if they are an easy read, are interesting, lets me empathize with the author who also serves as a role model, inspires me, teaches me, and provides and provokes ideas. This book did all these. I also like knowing how successful people got started – he is a self-made man worth $5 billion according to Forbes. Read it! You’ll like it!

Do you want a recognize an entrepreneur in your network? Withum is currently accepting nominations for our Entrepreneurial Strength Award! Using social media, simply nominate an entrepreneur and use #StrengthStory and tag @withumcpa! A member of our team will follow up with you for more details. Nominations are due August 22! For additional information, please visit https://www.withum.com/strengthstory

An investment story

August 10, 2017

Once upon a time there were a bunch of people that worked hard and spent less than they made. They used the money they did not spend to invest so they could earn interest, dividends and possibly capital gains. They called this unspent money savings.

Some of the people did not want to make investments that they thought were risky so they invested in risk free and safe investments. Other people wanted to make more than they could on the safe investments and they invested in riskier investments. The people with the safe investments saw their money grow steady – slow but steady; and they felt secure. The people with the riskier investments also saw their money grow steady, however it was at a faster rate. They never felt entirely comfortable but were OK with it since it grew at a much greater rate than if they invested in a way that they would have felt completely secure.

One day a terrible thing happened and the people with the risky investments saw their assets steeply drop in value – as much as 50%. They felt miserable, uncomfortable, insecure, and angry. The people with the safe investments did not see anything drop at all, and they felt very happy, comfortable and secure.

Well, a funny thing happened afterwards. It seems the people with the safe choices started to get paid much less for their savings – in some cases there was a drop of 60% to 70% in the interest paid to them. Their principal remained the same – untouched – safe and secure – but the income dropped so much that they started to feel miserable. On the other hand, while the people with the risky investments saw their assets drop greatly, the dividend checks they were getting hardly dropped at all. Their cash flow remained the same – they still felt insecure, uncomfortable but only had minimal changes in their cash flow and they did not have to curtail too much of their spending.

And then one day their assets went back up to what it was before the drop, so they started to feel much better and began to forget that they once felt so miserable, and the dividends kept coming with continued increases. So, life went on as it was before the terrible drop. They still felt somewhat insecure, but weren’t feeling miserable, uncomfortable or angry.

The people with the safe savings were receiving so much less income that they started to feel miserable – and that made them feel less secure and uncomfortable and angry. And they started to figure out how they could cut back on their spending.

The people with the safe investments had insured bank certificates of deposits. The people with the risky investments had their money in a diversified stock portfolio. The drop described above occurred from the beginning of 2008 through the end March 2009.

The moral is that risk is subjective, needs definition, understanding and a focus on the goal of what is more important – secure asset values or a sustainable and reasonable cash flow.

A Wise, Rich and Depraved King

August 8, 2017

Once upon a time there was a very wise and rich king. He was known throughout the entire world and his opinions and judgments were constantly sought. Whenever someone wanted to speak with him they brought him massive gifts of precious metals, jewels and wives. He is said to have had over 1000 wives and concubines [but only three children – a son and two daughters].

He was very smart, but also very greedy, strayed from his father’s belief in God and became a depraved person. While he inherited a great kingdom, he made no plans for his succession and his kingdom disappeared with his people dividing and warring with each other, and then being conquered, exiled and scattered. This occurred between 931 BCE and 586 BCE.

Some 2100 years later in the 15th Century CE his gold and other wealth was still being searched for. One such man was Christopher Columbus who got the backing of the Spanish King and Queen. He searched for but did not find the King’s hidden wealth when he landed on what is now America. 76 years after that another Spanish explorer, Alvaro de Mendaňa de Neira, led an expedition looking for the King’s gold in the vast South Western Pacific Ocean and came upon a group of Islands. While they were not successful, they nevertheless named the islands for this wise, rich and depraved king and called them the Solomon Islands.

Even today there are still those who think they can find the wealth of David’s son, King Solomon.

You Should Always Know Where are You Going, and Where You’ve Been

August 3, 2017

Once upon a time a man organized a three-ship journey toward the west. He thought he arrived where he was going, but the map he had was wrong. Somehow, a few thousand miles of the Earth’s circumference was missing from the map.

He also wasn’t as successful as expected since the anticipated gold and other riches did not materialize. When he returned home, to divert attention from his lack of success, he started boasting about what he discovered using Biblical analogies and something about finding the Garden of Eden. He also thought he found a new route to the other side of the world. He went on a couple of more trips embellishing the same stories each time he returned. Meanwhile other people started following his route.

About 10 years after that first trip, one of the people that travelled his route wrote descriptions about the land he saw where the men and women went about their business completely naked and the women appearing attractive and lustful. He also claimed to have discovered a “New World.” His descriptions were printed and interest in them spread quite rapidly. Around that same time a map maker in Italy named Corvino published a map showing the previously unknown and unnamed new land.

Five years later a German mapmaker was putting together a world map and was combining information from previously printed maps and included the land mass shown in Corvino’s map. Wanting to name it, mapmaker Martin Waldseemüller and his partner Matthias Ringmann chose a version of the now popular writer’s name. Thus, because of the rapid spread of the descriptions with the sexual content, the previously unknown land mass was called America after Amerigo Vespucci.

It seems that Vespucci’s sex filled letters were more interesting to the prurient readers than Columbus’ attempt to boast about what he found using Biblical analogies. It also proved that truth can be stranger than fiction…or boasting. And possibly that believable sex sells better than unbelievable Bible stories.