Chapter 2
Three basic reports

Your outside accountant delivers an envelope with your fleet’s financial statements and tax returns inside. You might politely listen as he rattles off a few comments. You’re mostly concentrating on the tax return. Do I owe a lot? Do I have the money to pay?

You receive potentially the most important document regarding your company, but you can’t understand or read it. CPAs and company accountants toil for hours, only to have you ask a question they are totally unprepared to answer. Worse, these reports are often tossed aside, or dropped in a file, never to be seen again.

Why does this happen? Because more than 80 percent of business owners or managers probably don’t know how to read and understand financial statements. But if you’re in that group, the last thing you’ll do is admit it. Accountants being what they are, the last thing they’re prepared do is help you learn.

Your ‘user’s manual’
The typical annual financial statement prepared by a local or regional accounting firm will follow this format:

• A title page
• A table of contents
• The accountant’s report
• The balance sheet (sometimes called a statement of financial position, or financial condition)
• The income statement (sometimes called a profit/loss statement)
• The statement of retained earnings or equity capital
• The cash flow statement
• Notes to the financial statements
• Supplementary information

Some annual reports — and almost all internal monthly ones — omit all but the basic two financial reports: the balance sheet and income statement. The first two items are self-explanatory, so let’s look briefly at the others:

The accountant’s report. The accountants’ professional standard-making body, the Amer-ican Institute of Certified Public Accountants, requires that accountants attach a certain report to any financial statement that they help prepare. This report informs the reader of the procedures, and the level of verification, if any, the accountant used in preparing these numbers. It will be one of three types of reports — compilation, review, or audit — in increasing levels.

Compilations are most common. Banks usually require reviews only when your loan balances top $3 million or more, and audits usually are required only when loans top $5 million. In a compilation, the accountants simply compile your numbers with only minimal verification of the details. This can be tedious depending on your accounting department’s level of sophistication.

In a review, accountants perform more detailed, but still summarized, analyses of your numbers, looking for anything unusual. In an audit, accountants invade your company, scrutinizing the numbers in detail, contacting your customers and vendors to verify their accounts with you and using rigorous procedures to give the reader the utmost assurance that nothing unusual came up during the examination.

The balance sheet. This first of the basic three reports presents the overall financial condition of the company on a particular date — usually the company’s fiscal year-end date. Think of the balance sheet as a snapshot — a still photograph of a single date in the company’s history. Ask your accountant to prepare the report showing not only the current year, but also at least one prior period for comparison. The best reports cover three to five years, so trends are obvious.

The balance sheet reflects the overall property the company owns as assets, and lists the debts as liabilities. The difference represents the owner’s net equity in the assets. It’s like your own home — it has a total value, and you owe a mortgage. The difference is what you would get if you sold the house.

Balance sheets break assets down into three types — current, fixed and other — in approximate order of your ability to convert them into cash. Current assets include cash, accounts receivable, driver advances, and expenses prepaid for the next twelve months. Fixed assets include the cost of your trucks and trailers, the office and shop equipment, and your building, if your company owns it. Other assets might include very long-term investments, such as advances to a subsidiary company.

Similarly, liabilities — current and long-term — appear in approximate order of when you must pay them. Current liabilities include short-term working capital bank notes or lines of credit, vendor or trade payables, driver settlements due, payroll taxes due, income taxes owed and the portion of your long-term debt due in the next 12 months. Long-term liabilities typically include your equipment notes and bank notes where the term of repayment is one year or longer.

The equity section is often called stockholders’ equity if a corporation, partner capital if a partnership or member capital if a limited liability company (LLC). This section frequently shows the owners’ initial capital investment, known as capital stock or partner capital contributed. It also reflects retained earnings — profit earned by the company but not yet distributed as dividends.

The income statement. If the balance sheet is a photograph, the income statement is a mo-tion picture; it covers not a single day but a period of time — a year, a quarter or a month. It reflects the income and expenses of the company, and the net profit or loss for the period of time covered.
Frequently called the profit/loss, or P&L for short, this vital report starts with revenues and then subtracts cost of operations or variable expenses.

After this subtotal, the income statement deducts operating expenses, often known as overhead or fixed expenses, to produce income or loss from operations. Next, the statement adds or subtracts other income or expense items, such as interest expense or non-operating income. Finally, the statement deducts income taxes to produce net income — which you hope is a positive number!

The income statement may separate your revenues into relevant classes. It may, for example, list revenue from company-owned trucks separately from those that are leased. Variable costs or cost of operations may show the same breakdown for fuel, driver compensation, tires, etc. — anything that might vary according to activity. Generally all companies have the same types of overhead — administrative salaries, rent and occupancy, office supplies, accountants and lawyers, etc.

Beyond this, it’s impossible to say what’s in your P&L statements; accounting practices vary widely. Some report the cost of interest as another expense; others put it in overhead. Depending on your company’s type of legal organization, financial statements may or may not reflect income taxes all the time. For LLCs and S corporations this expense often doesn’t appear on the P&L, based on the rationale that those taxes aren’t a company expense since they’re figured on the owners’ returns. (More on legal structures in Chapter Nine).

The statement of retained earnings or equity capital. This most mysterious report tries to reconcile the starting and ending equity on the balance sheet. This statement generally covers the same time period as the income statement. Retained earnings rise if the company earns a profit and falls if the company posts a loss or owners withdraw dividends. It also often includes changes in other owner capital accounts, such as common stock, treasury stock or partner capital contributed. Owners usually draw a salary. Owners may withdraw funds for many reasons, such as a return on investment or to pay income taxes.

The cash flow statement. By far the least understood — but most important — of the financial statements is the cash flow statement, which covers the same time period as the income statement. This critical report contains three basic sections: cash provided by or consumed in operating activities, investing activities and financing activities. In other words, the cash flow statement shows where the money came from and where it went.
The cash flow statement can show how you can have huge profits, owe lots of taxes and have no cash in the bank. Many smart financial advisors say that if you only understand one financial statement, this should be the one. “Cash is king” is the mantra in any business, especially for thin-margin trucking.

Notes to the financial statements. Want to know the company’s “dirty little secrets”? The notes are where you’ll find them. These detailed explanations of the company’s lines of business, key customer segments and accounting policies show the equipment types owned, investors or lenders to the company and the company’s debt repayment schedule. Often, the related parties disclosures reveal total owner compensation and details of owner transactions through related companies. You might also find out the details of the company pension plans and learn whether the company is under litigation.

Supplementary information. Often, the basic three financial statements are presented in a very summarized fashion. On the income statement, for example, you might see just four lines — revenues, cost of operations, overhead expenses, and net profit. The supplementary information is the accountants’ way of presenting the details. These are often detailed schedules or breakdowns of revenue, cost of operations, or overhead costs from the income statement, or certain asset or debt categories from the balance sheet.

External use reports vs internal use reports. Remember to notice whether you are reading external use reports, such as those prepared by your CPA, or internal use reports, such as those prepared by your accounting department. Reports prepared monthly by internal employees are principally the income statement, balance sheet and cash flow statement. They often are much more detailed — so detailed, in fact, that they can be difficult to read.

In Summary
Your annual report may include a number of statements and reports, but the three most important are the balance sheet, the income statement (P&L) and the cash flow statement. Some reports, such as notes to financial tatements and supplementary information, provide details explaining the numbers in the basic three statements.