Chapter 10
Notes to the financial statements

Many annual financial statements — especially those that are reviewed and audited — include an extensive text section called notes to the financial statements, sometimes referred to as footnotes. Internal monthly statements almost never have them. The purpose of the notes is to explain critical background information behind the numbers.

Smaller trucking companies having only a compilation might elect to save money on accountants’ fees by leaving the notes out of the report entirely or by disclosing only the most important items. And sometimes there’s no real point in providing notes. If the report will be distributed only to two or three owners, there’s no sense spending money telling owners something they likely already know.

When you look at your financial statements’ notes section, you’ll see several numbered or lettered notes. While no two statements present the notes in exactly the same order, the most common ones are:

Note 1: Summary of significant accounting policies
Note 2: Deposits or marketable debt and equity securities
Note 3: Notes receivable or other assets
Note 4: Equipment and leasehold improvements
Note 5: Long-term debt
Note 6: Operating leases
Note 7: Income taxes
Note 8: Related party transactions/inter-company balances
Note 9: Major customers
Note 10: Concentration of credit risk
Note 11: Retirement plans
Note 12: Stock or equity disclosures
Note 13: Contingencies or lawsuit disclosures
Note 14: Subsequent events

The summary of significant accounting policies recaps the methods of accounting and how certain items are treated. Here, you’ll learn if the company uses accrual or generally accepted accounting principles (GAAP), or the income tax or the cash bases.

This note discloses other vital information that helps the reader determine how you prepared the financial statements. One section, for example, discloses the names of subsidiary companies included in the numbers, if any. Another may give details of the company’s history and lines of business. Others might discuss the fleet’s composition and depreciation policies or describe how income taxes are treated. The note also might describe how the company treats various issues, such as amortization, advertising and deferred income taxes.

Deposits or marketable debt and equity securities notes detail the company’s checking-account balances. Some bigger companies often use excess cash to invest in securities. Because investments’ risk levels and market values vary, it’s important to know what types of investments the company holds — bonds or stock — and if there are unrealized gains or losses.

Notes receivable or other assets disclosures describe unusual assets. Selling equipment to a driver, for example, might create a note receivable. The repayment terms are important to some financial statement readers. In other cases, there may be significant loans to other companies, details of which are critical to gauging the collection risk.

Equipment and leasehold improvements notes can tell a great deal about the type and age of the company’s fleet and other company facilities and equipment. On many balance sheets, there is simply a large single number for fixed assets (net). The note can break down this number, disclosing the cost and accumulated depreciation, by asset class. Leasehold improvements are buildings or renovations on leased property.

Long-term debt may give the actual lender’s name, as well as the key terms of multi-year debt. What is the monthly debt service total? What key equipment or other assets are pledged to secure the loans? One key section often gives a year-by-year schedule of the principal maturities for the coming five years.

Operating leases are commitments for power unit, trailer or building rentals. Because many companies choose to lease these items rather than buy them, a key obligation arises, often for several years into the future. Without this disclosure, it might be impossible to see how much of future years’ cash flow is committed for these obligations. The key item to review is the non-cancelable portion of minimum lease payments — a fancy term for the total of lease payments you are committed to pay, whether or not you use the equipment. For fleet leases where there are mileage charges, these may be disclosed here.

Income taxes can be handled in many ways, depending upon the type of legal entity. This footnote explains how the company handles them. Are they recorded on the books? How much has been set aside or distributed for tax expense? Sometimes, unusual book-to-tax differences are detailed, showing expenses the company paid out but were not deductible for tax reasons. Examples of this might be amortization of certain assets or penalties and fines.

Related party transactions/inter-company balances is a critical note. Owners or officers of the company receive pay and benefits, and also may borrow money from or loan to the company. This note details these items. More importantly, if these individuals own equipment or facilities and lease them to the company, the terms are disclosed. If there are brother-sister companies, any funds advanced to or owed to these companies are disclosed.

Major customers can make or break a company, especially if they terminate the relationship or fail to renew contracts. So, if a contract comprises 10 percent or more of total revenue, this note will disclose its name and revenues so the reader can evaluate the risk. Related party companies’ revenues will also be shown here.

Concentration of credit risk for trucking companies generally focus on two areas — accounts receivable and cash or investment balances. A/R usually is a huge number, but large A/R to any one or a small group of customers is a concentration of credit risk. Generally, you must disclose any customer responsible for more than 10 percent of your total A/R. This note also will show whether any one bank or investment broker has a large cash or money market balance.

Retirement plans footnotes disclose the type or types of plans you offer — profit sharing, 401(k) or pension plan — and the key qualifications for participation, such as age limits and vesting schedule. This note often details company contributions and liabilities. Of particular interest would be a defined benefit plan, which is quite rare these days. If one exists, read this note carefully to see if the company has made adequate deposits and investments to pay for this expensive plan.

Stock or equity disclosures provide greater detail and understanding into the types of ownership classes. Preferred stock, for example, often has significant rights to dividends compared with common stock. Looking into how many shares are authorized, issued and outstanding lets you know if the company can issue more stock and dilute your ownership.

Stock options are often used as incentive pay for certain management positions. If the company has a plan, it should disclose how and when these options can be exercised. This information alerts readers to possible further dilution of their holdings should these options be exercised. While not common in non-public companies, they do exist. And if you were lending to or investing in a company, you certainly would want to know the rules governing stock options.

Companies sometimes buy back their stock or equity from owners. If this has occurred, a footnote will disclose the transaction’s details.

Contingencies or lawsuit disclosures notify the reader of the possibility of a future loss or gain and describe the circumstances of the contingency.

Companies may be defendants in several lawsuits or may be undergoing regulatory actions — audits by the IRS, Wage & Hour Division or OSHA. Often it’s impossible to declare how much these items may cost; indeed, doing so may damage the company’s ability to defend itself and win the cases. So accounting standards require the accountant to alert the reader to the possibility of loss and leave it up to the reader to investigate further.

Subsequent events are events or occurrences that happen after the close of the company’s fiscal year, but are important enough to merit attention in the financial statements. If your company has a September 30th fiscal year-end, for example, your financial statements might not go to banks until early December. Suppose that in late November, a very large customer who owed you 20 percent of your accounts receivable declared bankruptcy. This is an event subsequent to the end of the year. The effects of this event may be unclear at the time of the report, but disclosure is necessary. Without this disclosure, readers can’t assess the true financial condition and risks of the company.

In Summary
Notes to the financial statements, or footnotes, explain many things that otherwise would not be apparent in simple columns of numbers on the three basic reports. They are intended to disclose information that helps explain the numbers in greater detail, and informed readers would not look at a set of financial statements without studying them in great detail.