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Kristine’s Question

How do I reconcile a P&L to the previous year’s return to be sure the current income is on track?

I’m fine calculating S/E income of all types, but sometimes a P&L comes in that’s so convoluted I cannot make heads or tails of it.

They never look the same from company to company, and I want to be sure I am giving them the benefit of all they’d be entitled to if it were an actual return (just to measure the trend).

Linda’s Answer

You are so right. Some financial statements are convoluted AND do not follow the same rules as tax returns in significant ways.

Here are several answers including what to do if reconciling does not work.

If they are both on the same basis (cash or accrual)

Cashflow the financial statement in the same way you cashflow the tax return

Bottom line, add back depreciation and other noncash, scan for non-recurring, add back interest, and either subtract debt or enter it on a global debt list. (Of course, there is more to it, but you get the idea.)

In your scenario, you do not have a tax return to tie the financial statement to, just a prior year’s return. If you also have the financial statement of that prior year, to tie a financial statement back to a business tax return, the M-1 schedule will show you net income per books (that should tie to the financial statements) and all the adjustments to get to taxable income.

Typically, this is non-deducted expenses (meals as an example) or non-taxed income.

Since depreciation on a financial statement is different than depreciation per tax rules, there may be two adjustments to depreciation on the m-1.

As long as the m-1 adjustments seem to make sense and are reasonable, I am not concerned.

Different basis of accounting

If the tax return is cash basis and the financial statement is accrual basis the M-1 should include a cash-to-accrual adjustment, but only if you have both the financial statement and tax return for the same year

With an accrual basis financial statement that includes a balance sheet, take a look at the beginning and ending receivables and payables.

If they are close, then the accrual basis financial statement cashflow will not be that far off from the cash basis tax return cashflow.

If they are significantly different, you run the risk of dropping revenue out or including it twice. If that is the case, consider asking for the financial statement of the previous year and do your analysis with the two-year accrual basis financial statement.

This is not straightforward

I am guessing that was not the clean answer you were hoping for, but that you knew it was not going to be simple. If the trend goes really wonky bringing the financial statement numbers into the picture, ask questions to understand if the business actually did get out of trend. With the pandemic, supply chain issues, interest rate increases, inflation and labor issues, it is not unreasonable that things are changing.

If the reasons are still pandemic-related, remember that our regulators said they would not unduly criticize us for making prudent judgments to assist borrowers in short-term setbacks.

Good questions to ask

What is prudent? What is short-term? Hard to say. Document your conversations with the borrower and your thinking so you have a leg to stand on when they take a look.

Tax Returns and Financial Statements in our online training

Lenders Online Training includes both. Our virtual meetings cover the story behind the numbers when you understand both. 

Click here to explore the training that can help you say ‘yes’ to good loans; easier, faster and with more confidence.


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Linda Keith, CPA

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.