Every business needs financial statements so entrepreneurs and managers can monitor performance, attract investment capital, and borrow money. Not all financial statements are created equal, so as a business owner, you need to know what type is going to serve you the most.
Audited financial statements are considered the “top tier” in financial reporting. While public companies are required to issue audited statements, smaller, privately held organizations have other options. If your business has debt or private investments there may be a stipulation in the lending agreements, what we call loan covenants, requiring a specific type of statements. Be aware of that requirement and the cost you’ll incur to comply when signing loan documentation.
Certified Public Accountants can provide three other types of financial statements, which, in order of descending level of diligence, are: reviews, compilations, and preparations.
The newest and most basic financial reporting service available to private businesses are preparations. Compilations were previously the most-basic level of financials released by CPAs, so let’s discuss how these engagements differ from compilations.
Preparations
Financial statement preparations are often created as part of bookkeeping or tax-related work. While some lenders may accept preparations in support of small lending arrangements, preparations are generally intended for internal purposes to provide information on the business’ current financial condition and as a basis of comparison against future years and accounting periods.
The most important thing to note, preparations provide no assurance regarding the accuracy or completeness of the financial statements. Assurance is a critical part of financial statements if you plan to share them with third parties. In general, the greater the level of assurance, the more trust a reader will have in the accuracy and integrity of your company’s financial statements. This is why we consider audits as the highest level of statements, as they provide the most assurance of completeness.
Independence is another key component to audited financial statements that speak to the level of assurance. Professional standards don’t require a level of independence for preparation of financial statements. In other words, accountants are allowed to have a financial interest in a company that he or she prepares the statements for.
To avoid misleading anyone who receives a copy of these statements, each page of a prepared financial statement must include a disclaimer or legend stating that no CPA provides any assurance on the financial statements. In addition, prepared financial statements must adequately refer to or describe the applicable financial reporting framework that’s used and disclose any known departures from that framework.
Compilations
Like preparations, compilations provide no assurance that the financial statements are accurate and complete. And independence isn’t required when issuing compiled financial statements. But there are subtle differences when moving from a preparation to a compilation.
A compilation involves the issuance of a formal report by a CPA who’s required to read the statements and evaluate whether they’re free from obvious material errors. The CPA’s report appears on the first page, before the financial statements. If the CPA isn’t independent of the business, he or she must disclose this fact in the report.
Notably, the use of a compilation of financial statements can extend beyond the business owner to third parties, including investors, business partners and lenders who may view the input of a CPA as beneficial. Firms issuing compiled financial statements often have to obtain peer-reviews from other CPA firms as part of their normal practice, which is another degree of assurance that the statements are properly presented. This is not typically required for CPAs issuing prepared statements.
Building for the future
Preparations may be a cost-effective way for small business owners to monitor performance. But they provide limited usefulness as a business grows and needs to interact with third parties. Eventually, prepared statements may need to be upgraded to a compilation, review, or audit to give stakeholders greater assurance about the company’s financial results.
Contact us to determine what’s right for your current situation.
