Business Accounts
Key tips for lawyers in interpretation of business accounts
An understanding of business accounts is a valuable skill for lawyers, particularly those in family law or litigation/dispute resolution. The starting point is to understand what the legal status of the business is because this will impact the available information, the valuation methodology, the taxation and how a financial dispute can be resolved.
The starting point is to establish whether the business trades as an incorporated entity (a company, LLP or joint venture) or an unincorporated entity (a sole trader or a partnership).
Unincorporated entity accounts
Broadly, an unincorporated entity prepares accounts for its owners and to comply with its tax reporting. The accounts are not normally published and are of a more simplistic nature compared to those for an incorporated equivalent. A larger unincorporated entity such as a partnership will need to prepare its accounts in accordance with UK GAAP (Generally Accepted Accounting Principles) in order to comply with tax regulations.
Incorporated entities
Incorporated entities will need to prepare accounts that comply with the appropriate Companies Act and there is a requirement to publish a version of the accounts on Companies House. However, the set of accounts on public record is typically a slimmed-down version of the full accounts and so is of limited value when advising clients. Smaller companies are not required to file a profit and loss account so the published accounts give minimal information on the level of turnover and profitability. In advising clients and valuing businesses we require the full company accounts including the detailed profit and loss account. This is the version which is prepared for the shareholders and tax reporting.
Interestingly, there is a significant change coming whereby small companies will again be required to file substantially more information in their published accounts including a profit and loss account.
External review and the audit of published accounts
The limits for the statutory requirement for an external audit have been reduced over the years and less than 10% of companies are required to have an audit. Therefore, in most cases, although the published accounts may have been prepared by an external accountant, they have not been subject to the level of scrutiny that an audit requires.
The key components of published company accounts
The key constituents of the published company accounts for large companies are shown below. The useful report that is not included in the public accounts is the detailed profit and loss account.
Red Flags
What do we see as red flags in analysing financial statements? Here’s some examples:
1) A qualified audit report is a massive red flag. This indicates that the auditor was unhappy with some aspect of the financial accounts.
2) Reported profits exceeding operating cashflows. This suggests there may be a cashflow problem.
3) Increasing stock or work in progress which might indicate obsolescent stock.
4) Contingent liabilities. These liabilities will not be in the accounts but could have a significant impact in the future.
5) Related party transactions. Such transactions may not be at a commercial rate or could mask performance issues.
6) Prior year adjustments.
7) Late filed accounts. Late filing may indicate issues with the accounting records, disputes with the auditors or funding problems.
Conclusion
In a brief article like this, we cannot cover all of the intricacies of financial reporting. However, the starting point is to ascertain what accounts are available and whether they have been subject to any external scrutiny. We then look at the trends and relationship between the numbers, as well as any red flags.
A forensic accountant has considerable experience in the cold review of published financial accounts and it may be worth requesting an initial view on the accounts at an early stage in any financial dispute. At FHM Forensic Accounting we can provide a fixed fee for the initial review of published or disclosed accounts.
Getting in Touch
Fee estimates and CVs are readily available. Quotes can typically be provided within two working days.
Email: fiona@fhmforensic.co.uk
Telephone +44 (0)7770 642491
