Are Your Financial Statements Accurate? 3 Reasons to Understand Basic Accounting

Many CEOs do not have a clear understanding of their company’s financial statements. This isn’t necessarily due to lack of effort or interest—often it boils down to a combination of lack of time, misaligned accounting management and/or poor communication between the C-suite and the accounting department. However, rest assured that to improve this dynamic doesn’t require a master’s degree in accounting—rather a simple understanding of the key questions and principles that will unlock the information and understanding you need to better oversee your business.

Reason #1: Your Gross Profit Margins Are Way Off (Really, Really Off)

The biggest problem we see on a regular basis is an inaccurate understanding of the company’s gross profit margin. When determining pricing, future cost outlays, budgets and cash flow forecasts, a clear picture of your gross profit is critical. In fact, even being off by a few percentage points can ruin your company if you aren’t careful.

If you suspect your gross profit margin is a bit murky, start by checking the severity of the problem. First, you need to make sure that the cost of goods or services sold is based on the appropriate indicators. Often, many bookkeeping mistakes are a result of improper classification, putting too many or too few expenses in the wrong categories. Your gross profit margin is based on a simple formula of “sales minus the cost of good sold” but if your cost of goods sold include costs that should be accounted for under another expense category (or don’t include enough of your costs), your gross profit margin could be way off.

Determining whether an expense is part of cost of good sold or should be assigned to your general and administrative expenses is a key part of this—ask your bookkeeper or controller where each expense is allocated to ensure your gross profit margin is truly representative. An accurate gross profit margin is critical to determining pricing and budgeting—after all, the gross profit is the money left to pay salaries, expand the business or invest in improvements.

Reason #2: You Have Inventory—But You Don’t Know The Half Of It

Accurate inventory valuation is a critical part of your balance sheet. The reported amount will directly affect everything from your gross profit and net income to working capital, total assets and equity. Yet somehow we find many businesses suffer from major inventory management and valuation issues. If your business has inventory, it is imperative you have a clear understanding of what populates the numbers on the back end.

Does an inventory management application support the numbers you see on the balance sheet? How often is inventory accounted for and is there a follow through from one period to another? For example, the ending inventory of one accounting period should become the beginning inventory for the period immediately following—so if you see a discrepancy in numbers, this should automatically alert you to a problem in your reporting.

Additionally, accurate cash flow projections and ordering depend on accurate inventory management. From keeping the right amount of inventory on hand to ensuring your mark ups are accurately related to what you paid for it, knowing what your costs of inventory are will help prevent you from using up more of your revenue to pay for your inventory.

Reason #3: There Are Uncleared Payments That Are Many Months Old

Do you currently receive A/R and A/P aging reports on a regular basis? Do you have uncleared payments or outstanding invoices that have been stuck there for months on end without a change? Accurate balance sheets and financial reporting can help alert you to these problems and keep you on top of these issues. It also helps alert you to whether your accounting processes and procedures are being followed and adhered to by your accounting staff.

Do you have a process for chasing unpaid invoices? If you have significant outstanding A/R, you may have revenue but not the cash on hand you expect. The right accounting processes have measures in place to stay on top of these issues—but a lack of adherence could be preventing you from getting paid. Asking the right questions about why old A/R are still outstanding can help you stay on top of your team and keep your cash flow on pace.

Staying on top of your balance sheet and financial statements is critical to the health of your business—but it doesn’t mean you have to become an accounting professional to do it right. AccountingDepartment.com co-founder Dennis Najjar, CPA can help you understand what to look for, what to ask about and why you need to know—so you can be confident you know your true financial picture.

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