When most people look at the financials to see if the numbers look right, they check out the income statement.  That’s good, but it isn’t the real test.

 

Check the balance sheet.

 

If the balance sheet is wrong, then the financials are wrong.  If the balance sheet is right, then the cumulative financials are right.  If the income statement is right, the financials could still be wrong- there could be a prior period mistake that has still not been caught.

 

If someone tells you they think the numbers are off and talk about the net income being too low, ask them this question back- “What part of the balance sheet do you think is wrong?”  That usually quiets the conversation.

 

A general manager at one client thought his incentive was low for the month.  I asked him the above balance sheet question.  I pointed out that for income to be too low, it would usually have to mean that either inventory was overstated or payables were overstated.  I indicated that I was confident about both of those sets of numbers.

 

If you think your income is too low for a month, give your balance sheet the same test:

 

·         Assets- would have to be understated:

o    Receivables- Are there any missing receivables which mean missing revenues on the income statement, such as other sources of revenue?

o    Inventory- Is some inventory missing, such as in-transit inventory, or is inventory undervalued due to not capturing all the costs that go into inventory?

o    Prepaid Expenses- Are there prepaid expenses that extend over the year that have been expensed instead of being capitalized and amortized?

o    Fixed Assets- are there fixed asset additions that were expensed rather than capitalized or was too much depreciation taken?

·         Liabilities- would have to be overstated

o    Accounts Payable- are there bills that were booked that really pertain to a future period?

o    Accruals- are some expenses being over-accrued?

o    Deposits/Dues- have some customer deposits or dues now been earned?

 

Use this as a guide.  You might have other key assets or liabilities to consider. 

 

When you think the income statement might be off, don’t spend time on the income statement. 
Take a walk up and down the balance sheet.