A financial statement provides an overview of the financial activities of a business or individual. In business, these statements can be crucial to helping a business owner quickly identify areas of concern. It can also prove helpful in determining whether a business has the finances in place to grow. When seeking financing or partnerships, businesses will often pull financial statements to give concrete evidence of the company’s value.
Whether a business uses accounting software or manual processes to create financial statements, mistakes can be difficult to avoid. Yet even one small error can lead to costly issues for any company that relies on its numbers to make decisions. Here are a few common errors that tend to appear regularly on business-based financial statements.
The biggest mistake made on balance sheets applies to classifying assets and liabilities. It can be confusing, even for financial professionals, since assets and liabilities fall into different categories.
There are current liabilities and long-term liabilities, current assets and long-term assets, and owner’s equity. A business could accidentally put a long-term liability into the current liability column, effectively increasing the amount of debt that will need to be repaid within the coming year. This small mistake could cause a business to lose clients or even investor capital, since its finances may look less stable on paper.
At one time, it was common practice to “close the books” at the end of the year and refuse to reopen them, since that information isn’t expected to change. However, the software solutions many businesses rely on don’t always have a feature that locks books at the end of each year. This leaves previous balance sheets open to accidental entries after the fact, changing a business’ balance.
Businesses should try to put tools in place that will preserve previous years’ balance sheets as historical documents. If this isn’t possible, business owners should regularly check the balance to make sure it hasn’t changed.
It can be easy to make an error on an income statement, since accurate reflection means recording every dollar of sales that comes in. One missed sale can throw off a business’ profitability ratios, since its profit margins will be lower than statements show. Since this information is used to value a company, repeated instances of missed sales can lower a business’ numbers, potentially keeping it from getting the bank loan or funding it needs to move forward.
In addition to recording every single sale, businesses must also accurately account for each operating expense. It’s easy to miss even the most obvious expense, especially if a business is putting an income statement together quickly. Expenses can include everything from salaries and benefits, to meals, bank fees and cost of goods sold. Errors in calculating operating expenses can lead a business to overspend, since these figures are also used to set future budgets.
Sometimes, a company will use a previous quarter’s figures when ordering new items, based on the cost of goods sold listed for that quarter. An error in this area could lead a business to order inadequate inventory to handle the upcoming quarter’s demand.
To get started on an income statement, download our free income statement template.
Cash Flow Statements
As with balance sheets and income statements, errors on cash flow statements can severely hamper a business’ picture of its financial situation. Misclassification can be a common area, since it can be easy to confuse items like cash and cash equivalents (i.e. assets readily convertible to cash).
Cash flows are usually divided into three major areas: operating activities, investing activities and financing activities. Businesses must know which items go into which categories. Operating activity cash flows are generated through the company’s core business, while investing activity flows come from money spent on the business or buying and selling investments. Cash flows from financing activities include items specific to a business and its creditors, such as taking out or repaying a loan.
According to the Securities Exchange Commission (SEC), cash flow mistakes are common enough to cause concern. Since investors place emphasis on cash flow statements when making decisions, the agency emphasizes the importance of making sure this information is 100% accurate. The SEC says many of the errors are basic accounting mistakes, such as failing to account correctly for capital expenditures purchased on credit.
It’s important that businesses know the difference between operational, investment and financing cash flow, and they must classify these flows appropriately.
To get started on a cash flow statement, download our free cash flow statement template.
Financial statements often serve as the backbone of a company, guiding its owners as they make major decisions or seek business partnerships. When errors are made, it can impact the business’ ability to stay competitive or win funding, among many other issues. By putting measures in place to prevent even the smallest errors, a business can protect its bottom line and ensure it has the most accurate financial picture available.
To make sure you avoid these errors, check out our free guide to financial statements and financial reporting.