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Financial Statement vs Tax Return Balance Sheet

Mike asks:

Is it better to use the balance sheet from tax returns or company prepared financial statements for credit analysis of assets, liabilities and net worth?

Linda answers:

Great question. And the answer is my favorite, it depends.

Advantage of tax return balance sheet:

The information has been sent to the IRS, so similar to relying on page one as the income statement, we assume the tax return balance sheet is more reliable.

Year-end work may have been done by an outside accountant/tax preparer who may have more knowledge than an internal accounting staff person.

Advantage of company-prepared balance sheet:

The format may be more appropriate for the type of business, such as construction, because the preparer has more flexibility than in the tax return format.

A company accountant may have more knowledge than the tax preparer, if that person or firm is not an accounting firm knowledgable about the type of business.

What to look for on any balance sheet

The Balance Sheet is more than just numbers and can hold significant clues to credit worthiness. In tax return analysis, lenders and analysts often have a laser focus on cash flow generated from operations available to pay debt.

But don’t miss out on the clues ‘hidden’ in any balance sheet. Read this post on Crazy 8: Clues to Credit-worthiness from the Business Balance Sheet.

Caution!

If the company-prepared statements are interim, they may not have year-end adjustments that the outside accountant/tax preparer generally makes. This is why you sometimes find a discrepancy between company-prepared year-end statements and the tax returns.

Since the balance sheet on the tax return is ‘per books and records’ there should generally not be a difference in the numbers, only the presentation.

What are the common differences between tax returns and company-prepared financial statements?

Looking at both Income Statements and Balance Sheets, sales/revenues can be different because of the difference in cash vs accrual basis. Net worth and expenses can be different because of different treatment of depreciation and of inventories, to name a few.

Generally, the Schedule M-1 is a good place to see the difference between net income per books and net income per tax returns.

We have a module for that!

Not a surprise, our bankers online training site includes financial statement analysis modules, including one specifically on ‘Balance Sheet Basics’. It is one of the free modules in our try-us-out set. Here is the link to the free modules at LendersOnlineTraining.com.
Free modules at Lenders Online Training

About the Author
Linda Keith CPA is an expert in credit risk readiness and credit analysis. She trains banks and credit unions throughout the United States, both in-house and in open-enrollment sessions, on Tax Return and Financial Statement Analysis. She is in the trenches with lenders, analysts and underwriters helping them say "yes" to good loans. Creator of the Tax Return Analysis Virtual Classroom at www.LendersOnlineTraining.com, she speaks at banking associations on risk management, lending and director finance topics.