Effective Financial Reporting System Good for Business

By JOSEPH BURNS Guest Columnist Privately held companies are not subject to the same stock exchange-required rules and strict government regulations that are compulsory for publicly traded companies. While this frees private companies from costly reporting and compliance mandates such as those of the Sarbanes-Oxley law, it does not excuse private companies from the need to set up and maintain timely and accurate financial reporting systems. Failure to produce good financial numbers is a recurring weakness in many of the companies I assist in my management consulting work. Some owners and senior managers ignore this flaw, because they prefer to work in areas in which they have greater understanding and comfort, such as the operational areas of the company. If you are in that group, here are three compelling reasons to step out of your comfort zone and begin to create or refine your financial reporting system. Like other management tools, it should be uncomplicated to use, and it should help you to generate sustainable profits: More than the bottom line An effective and well-designed financial reporting system provides much more than simply the bottom line; it produces the numbers upon which business decisions are made with a greater degree of confidence. For example, with good numbers, you can create a break-even model for looking at various scenarios involving capital investment, changes in staffing, or analyzing marketing and/or product mix. You can also use it to help establish sales and productivity goals. Your financial reporting system should also clearly reflect the cost structure of your business. In the absence of this knowledge, you lack a critical element of effective pricing decisions. For example, if one of your cost elements changes, how should that be factored into your pricing? Further, without a clearly defined cost structure, the ability to conduct any kind of job costing is also lost, along with its valuable insight that is not available anywhere else. As an owner or senior manager, it is essential for you to have financial tracking systems in place in order to provide an early warning of any potential problems. The best financial reporting systems form the basis for creating key performance indicators, which alert you to these possible problems, and which create the context and perspective in which you will spot trends and patterns. Lacking such indicators, you are forced to wait until problems become serious, and thus it takes a much larger effort to resolve them, with the obvious and many costs to the performance of the company. Tax implications During the first few years I owned and operated a business, preparing taxes was simply a nightmare because we did not have a good financial reporting system. Some records were kept manually, others on poorly designed and non-integrated computer files. The process of preparing our records for our CPA was frustrating, time-consuming and expensive. There was also the opportunity cost of taking us away from value-creating activities, that is, the work that generated our revenue and profits. When we finally did develop and put into place a good financial reporting system, tax preparation became a simplified process wherein we provided our records to our CPA, who would prepare our returns, and incorporate any appropriate changes in the tax law. He invariably had questions, but for the most part they were easily resolved. It was very different from the earlier years, in that our costs and stress levels were dramatically reduced. Should you find your company is the subject of an inquiry or audit, having defensible numbers, which are the product of a reliable financial reporting system, is an excellent way to reduce IRS or state tax liability exposure. In the eyes of the tax people, ignorance is slightly less damning than deliberate breaking of the rules, and therefore ignorance, due to a lack of good numbers, is not an effective risk reduction strategy. Suffice it to say that the stronger your financial reporting system, the better you will be positioned to address any potential tax issues. Analysis and valuation A major reason why companies are often turned down for bank financing is that lenders must base their decision on the company’s ability to prove that it is capable to repay the loan. Risk-averse bankers want to know, in the most demonstrable way, how and when you will repay them. An effective financial reporting system enables lenders to gain clarity into your company by analyzing financial ratios and other information that you generate. A successful financing is the product of good numbers that reflect the strength of your company, and the lender’s high level of confidence in the accuracy of those numbers. An effective financial reporting system also enables interested parties outside of the company to readily see the value in your company. This is important because when you reach the inevitable point of deciding the company’s future, your role in it, and that of your key employees, a company with a clear financial track record over time can command a higher price than one in which that value is not evident. Moreover, if there are decisions to be made with regard to succession planning, having a realistic valuation of the company, which begins with accurate financial statements, helps to clearly define what is at stake. Such decisions often include an emotional dimension for both owners and successors, but reliable numbers are the common ground leading to successful negotiations.