Maps and Financial Reports
by Mark J. O'Donnell
This month let’s talk about financial reports. To begin, literally start with the end in mind. Consider the basic requirements of financial reports. First and foremost, they must provide value, which can be expressed in three ways:
-Accurately measuring critical results and supporting decisions.
-Being understandable by the report’s primary users, including their best use and limitations.
-Satisfying outside interests (banks, taxing agencies, etc.).
An excellent and easy-to-understand analogy is a standard road map.
A road map only has value if it helps guide you to your destination. It must match the terrain and be accurate about the details of current roads, cities, states, etc., to be valid. We have all experienced a confusing or outdated road map that has taken us to unintended places. Similarly, your financial reporting (map) must match your business’s current economic reality (terrain). Without that information, management risks making bad decisions and suffering the outcomes; banks may make unfavorable creditworthiness decisions about loan applications; and your business may pay too much tax.
There are different kinds of maps, including road, topography, and weather maps. Each has different purposes and rules. For example, you cannot determine the high point in the area on a road map. You need a topographical map. These two types of maps share the same terrain but have different purposes and rules. Likewise, financial reports have two purposes and rules: reporting financial results using Generally Accepted Accounting Principles (GAAP) and paying (avoiding) income tax using the Internal Revenue Code (IRC). Similar to physical maps, these reports have different rules and purposes but are based on the same ‘terrain.’ Both are robust sets of rules with opportunities for improving our reported position and consequences for violating the rules. Just as you need to understand the basic rules for physical maps, you must have a basic understanding of GAAP and the IRC. OK, that doesn’t sound interesting to most business owners. Hang in there—more practical insights to come about GAAP and a bit about the IRC later.
Starting next month, we will focus on your basic financial statements to improve your understanding of the ‘rules’ for reporting to outsiders (GAAP) and additional beneficial options for your internal reports. The latter is a refined approach to having different rules for your internal financial ‘maps’ to better measure your results and help you make profitable decisions.
Next month’s article will be about balance sheets: what they are, why they’re essential, and insights about how to effectively use them. The rest of the reporting statements will follow.
Three takeaways for today:
1. Understand the purpose, rules, and use of your financial reports.
2. Recognize the difference between your reporting ‘maps.’
3. Insist on timely and accurate reports. Heads up. In case you missed it, the recently passed “Inflation Reduction Act” has some opportunities that may benefit you and your business. We summarized this information in a recent publication, “EMERGING TAX AND REGULATIONS” Please drop us a note at connectwithus@stcpa.com to get your copy.
Mark O’Donnell, CPA, is Partner at Schmersahl Treloar & Co. He can be reached at 314.966.2727.