What is the best way to tackle it when you receive company prepared financials and tax returns and the reconciliation seems to be universes apart? I rarely get compiled financials. With CRE’s I can usually find my way, but with other businesses it can be a challenge.
There are many differences between financial statements and tax returns. Credit Analysts and Underwriters need to assure themselves that the differences are legitimate and not a red flag indicating fraud. Here are a few of the possible causes and reasons:
The company prepared financials may be ‘preliminary’.
When I was in tax practice, some of the smaller and mid-size businesses did their own accounting through-out the year. When they came to me at year-end, sometimes changes needed to be made before I could issue the financial statements, whether compiled, reviewed or audited.
The company would not have considered them preliminary. But if the CPA firm that does the tax return would modify the underlying financial statements, you can see why they would be different.
- Legitimate differences between financial statements and tax returns
- The financial statements may be on the accrual basis and the tax returns on the cash basis
- There may be differences in depreciation methods
- There may be differences in inventory methods
If it is a 1040, no balance sheet is required. If it is a 1065, 1120 or 1120S return and the Schedule M-1 is included (not always required), it may give you some help on the differences between book income and taxable income.
In your write-up regarding the loan request, you may need to show you spotted, and reconciled, the differences.
Krista asked about training in her email. Both the tax return analysis and the financial statement analysis courses for lenders at www.LendersOnlineTraining.com will be helpful in using either financial statements or tax returns to make loan decisions with businesses or their owner/guarantors. There are some free modules to get you started.