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    06 / 12 / 2012

    Here's a Head-Scratcher - The Value of Audited Financial Statements

    I met with a banker yesterday from one of the top 3 big national banks. We were introducing him to AcctTwo and our business process outsourcing services for small and medium-sized companies. We thought he would appreciate knowing that his clients could use AcctTwo to generate more timely and accurate financial and management reports, and his bank would get their required financial statements and borrowing base covenant calculations much faster.

    And the Record Skips...

    So here's the head-scratcher. As he was asking us questions about what we do and how we work, he was naturally trying to think of possible concerns or objections his clients might have about outsourcing their finance and accounting function. This is normal, and he went through all the standard questions we are used to dealing with all the time. Until he asked the following question:

    "Many of our clients like to manipulate their financials so they can fudge their borrowing base covenants and hide money from the IRS. How do you deal with that?"

    Huh? Did I hear that correctly? And he said it with a completely straight face as if it was the most normal thing to say over lunch. Naturally, I had no answer for that.

    The Value of Audited or Reviewed Financial Statements

    Although this particular banker seemed to be ok knowing that his clients were fudging their covenant calculations, I would think most banks would like to know that they are being fed accurate information by their clients. (Although a seed of doubt has been planted in my mind about this...) This is why banks sometimes require their clients to provide annual financial statements that have been audited or reviewed by an independent public accounting firm. AcctTwo is not a registered accounting or CPA firm, and does not provide any form of assurance regarding our clients' financial statements. That is what an audit or a review is for.

    Prior to the economic downturn that began in 2008, I noticed most banks had loosened their requirements for audited or reviewed financials in an effort to stay competitive. I thought those standards had been tightened again in light of what happened as a result of several years of easy money, but now I am doubting that again. IRS audits are a completely different matter, and have actually increased significantly over the past few years.

    What is the Purpose of Your Financial Statements?

    This whole discussion made me think about whether all companies view the purpose and value of their finance and accounting function in the same way. If you look at your accounting function and the preparation of your financial statements as a necessary evil that only exists in order to satisfy the external demands of your bank or the IRS, you are probably running a lifestyle business that is generating enough cash for you to pay the bills and live at whatever standard of living you are accustomed to.

    If, on the other hand, you desire to sell your business in the future, or have some other type of liquidity event such as going public, this attitude towards your finance and accounting function is destroying the value of your company. Whatever you think your company is worth, I can almost guarantee you that it is worth significantly less in the eyes of a potential buyer if you take this approach.

    One of the first things a potential buyer of your company will look at is the quality of your financial and management reporting. They will want to know how profitable you are, by product or service, by industry, by customer, or whatever metrics and key performance indicators are relevant to your business. If you can't answer those questions, how can the buyer make an informed decision about how much your business is worth? More importantly, what does that tell the buyer about how you are running the company?

    I've seen companies learn this the hard way when they are subjected to their first audit, or first due diligence by a potential buyer. They are then scrambling to find information and produce reports that have never existed until asked for. This is a very stressful and painful experience, and undoubtedly leads to value destruction by providing the buyer with negotiating leverage. The impact of this is similar, although more subtle, if you are trying to borrow money from a bank or increase your line of credit. If this is the experience your bank will have as they request the information for your loan, I can assure you that they will be lending you less money, at a higher interest rate, than if you had timely and accurate financial reports.

    Accurate Financial Reports Are a Minimum Standard

    As Garry Meier, Chairman of the Ephor Group, stated at a recent panel discussion I participated in, "Accurate financial reports are a minimum standard." At the speed of business today, companies not only need to produce accurate financial statements on a frequent and timely basis, they need to be looking at key performance indicators (KPIs) on a management dashboard on a real-time or near-real-time basis in order to be successful.

    If you don't have accurate and timely financial reports, or real-time KPIs on a management dashboard, one thing is for certain: some of your competitors do. They will be driving their business looking out the front windshield and at the gauges on the dashboard. You will be trying to win the race by looking in the rear-view mirror (a foggy one at that). Good luck! I know who my money is on.

    Marcus Wagner

    Marcus is the founder and CEO of AcctTwo, a services and technology company delivering the Future of Finance and Accounting to nearly 1,000 organizations throughout the country. Marcus and his team have firsthand experience implementing the processes, controls, and technology needed to optimize financial resources, no...

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