Most of companies have a certified public accountant, CPA, who is involved to a varying degree with financial reporting, tax returns and day to day financial operations. However, in most cases the CPA does the taxes and that’s it. I often hear people say “we have a good CPA we didn’t have to pay much tax this year”. Needless to say, all business owners want to minimize taxes and when the CPA tells us we don’t have to pay a lot we are happy with him/her. Are we then unhappy with the CPA if we have to pay a lot of taxes? It shouldn’t be the case, if we properly use a CPA he helps us run the business in a financially efficient way and that includes handling the taxes. I think most small business owners underutilize the services the CPA provides and this article is meant to give my view of what a CPA can do for a small business.
Several parties are interested in looking at our businesses. They are the tax authorities, the lenders and the owners. Each of these parties looks at the business for a specific reason.
We have to file tax returns; it’s a legal requirement and has to be done every year with the sole purpose of providing revenue for our State and Federal Governments. The CPA’s role is to file tax returns that reflect our business according to State and Federal tax codes. Taxes can’t be avoided but with proper planning one can pay less tax on average, so use the CPA for tax planning. Furthermore the CPA’s role is to advise you on how to make timely payments of income, payroll and sales taxes as well as other government fees.
Finally, the CPA can provide a very valuable service in bridging the business owner’s corporate tax situation with his personal tax situation. Most businesses in our industry are 100% owned by the operator and the company’s financial situation is very closely connected to the owner’s personal financial situation.
Standardized Financial Reporting
The CPA provides standardized reports of different types. Your bank or other lenders are very interested in seeing your
financials so that they know what risks their loans are exposed to. In this case the CPA’s role is to provide financial reporting in a standardized format, the so called Generally Accepted Accounting Principles (GAAP). GAAP helps those outside your company understand and compare the financial position of your company to that of other companies in other industries.
GAAP includes local applicable Accounting Framework, related accounting law, rules and Accounting Standards. It is not a US Government Law but a standardization of accounting, rules, standards and norms for how transactions, evaluations, depreciation etc should be viewed. There are three basic principles for financial reporting according to GAAP.
The Financial Reports shall be:
- Useful to present to shareholders, potential investors and creditors and other users in making rational investment, credit, and other financial decisions.
- Helpful to present to shareholders, potential investors, creditors and other users in assessing the amounts, timing, and uncertainty of prospective cash receipts.
- Informative about economic resources, the claims to those resources, and the changes in them.
There are three levels of financial reports provided by the CPA’s in accordance with GAAP, Compilation Report, Reviewed Financial Statements and Audited Financial Statements. Here is a brief explanation of what each report entails.
Compilation Report: The CPA becomes familiar with the accounting principles and practices common to the client’s industry, and acquires a general understanding of the client’s transactions and how they are recorded.
After compiling the financial statements, the CPA is obliged to read them and consider whether they are appropriate in form and free from obvious material errors. The CPA then issues a standard report that says, in effect, that the financial statements were compiled, but because they were not audited or reviewed, no opinion is expressed.
A compilation is sufficient for most small private companies. However, it doesn’t provide assurance that the financial statements are reliable.
Review: The CPA obtains a working knowledge of the industry in which the entity operates and acquires information on key aspects of the organization, including operating methods, products and services, and material transactions with related parties.
The CPA then makes inquiries concerning such financial statement-related matters as accounting principles and practices, recordkeeping practices, accounting policies, actions of the board of directors, and changes in business activities. Thereafter, supporting documents from banks and creditors are examined along with those of selected transactions.
A Review—with its limited assurance —may be adequate for a business and/or its creditors.
Audit: The CPA gathers evidence on the reliability of the financial statements and performs “search and verification” procedures. In an audit, the CPA generally confirms balances with banks or creditors, observes inventory counting, and tests selected transactions by examining supporting documents. In addition, the CPA contacts sources outside the client organization to gather information that may be more objective than that obtained from internal sources. The CPA then issues a report stating that the financial statements are presented fairly, in all material respects, in conformity with generally accepted accounting principles.
An Audit provides a reasonable level of assurance that the financial statements are free of material errors and fraud. An audit does not, however, provide a guarantee of absolute assurance.
So which one of these reports do you need? It all depends on if you have reporting requirement and who you are reporting to. If your bank requires a certain level of reporting, you’ll do it to comply with their requirements. If you are looking for new loans or to increase you borrowing capacity you may want to have reviewed or audited financial statements to show the lenders that you are committed to high level reporting.
If you have a business with employees involved in your bookkeeping and accounting, you’d want to have a Review or an Audit as an assurance that they do things the right way and that there is no fraud, theft or misuse of funds. You have probably heard of many small businessmen saying that their trusted accountant, bookkeeper or employee embezzled money or stole merchandise. With an outsider like the CPA taking a detailed look at your books this is less likely to happen or can be discovered at an early stage.
If you are a passive owner you’d like to have an Audit for the reasons mentioned above. If your business has investors you’d like to have an Audit for the reasons above as well as to limit your own liability.
The CPA as an advisor
If you have your own small business, have good control of your accounting and finances as well as no requirements from a lender, you don’t need any of the financial reports mentioned above. However, you can benefit from having the CPA as a business advisor. Most small businessmen are isolated in their own world (see my recent article regarding Advisory Boards), and the CPA brings valuable knowledge from his specialty that can be beneficial for the small business owner. The CPA also has a network of local clients who can be customers, suppliers or investors in your business.
Use the CPA to look over your routines, internal reporting, operating systems, paper trails and other essential documentation. Have him look at your overall financial situation, personal and business, so that you optimize the use of capital as well as manage risks from a broader perspective.
A CPA provides three services to a small business owner, preparation of tax returns, standardized financial reporting and advisory services. Depending on the business owner’s personal preference and reporting requirements his CPA is more or less engaged in the business. The most common services are tax return preparation and financial reporting to lenders. These services basically describe what has happened in the company in accordance to the tax codes and the Generally Acceptable Accounting Practices, none of which helps to move the business forward.
As a small business owner you are not thinking about what you did in the past, but what you are going to do in the future. Give your CPA a call and talk to him about what he can do for you as an advisor. Here are a few questions that you can ask.
- Is my business correctly structured? Do I have the right corporate structure that allows me flexibility, minimal tax exposure and is a good foundation for growth?
- Can my business and I benefit from new relationships with banks, insurance agents and financial planners?
- How do I best set up a plan for the future ownership of my company?
If you engage the right CPA in the right fashion, I am convinced that you’ll see benefits that will help grow your business and set up a personal financial plan for the future.