“How do you know that my financial statements aren’t accurate?”

That is a question that I get over and over when I ask contractors for their financial statements. It’s actually pretty easy to tell. The first major clue is negative cash on the balance sheet.

Let’s say that I look at a contractor’s balance sheet. It shows negative cash of approximately $11,000. This is usually wrong because no banker is going to let you have negative cash in your checking account.

What usually happens is that the bookkeeper printed out all of the checks to vendors that needed to be paid. Unfortunately, there wasn’t enough cash in the checking account to pay them all. So the bookkeeper holds the checks. The computer program doesn’t care if you have a negative cash balance. All it knows is that accounts payable were decreased because the checks were written. It never checks to see if there is enough cash to pay the bills.

Holding checks screws up your ratios. You don’t have a true accounts-receivable to accounts-payable ratio. You think bills have been paid and they haven’t. Perhaps you’ll have a false sense of security until one Friday afternoon, after the bookkeeper has gone home, you find a pile of checks in his or her office that haven’t been sent.

OK, that’s too easy to spot. What’s next? A round number for inventory or inventory that never changes from month to month on your balance sheet. No contractor has exactly $5,000 - or $29,995 - of inventory. The Internal Revenue Service loves to use that as an audit warning sign. If you enjoy a visit from the IRS, just leave inventory as a nice, round number.

Accuracy

Without accurate inventory and job costs, you don’t have a clue how good your inventory “bets” have been. You don’t know if your material usage is too high. At the end of the year, you don’t want a surprise. If the inventory shows $50,000 on your balance sheet and your count is $40,000, then you have an additional $10,000 in material expense and $10,000 less profit on your bottom line.

Where did the $10,000 go? It’s easy to figure out: leave materials on a job, damage them in trucks or take two parts where only one is needed. And unfortunately, thefts happen occasionally.

Remember back to the first time you used a set of gauges? Confusing, wasn’t it? But after a while, you didn’t have to think when putting gauges on a system. It was easy. Financial statements are the same thing - they are tools. The first few times they are confusing. However, when you work with them regularly, they become easy to read.

Here are some other problems to look for when perusing your balance sheets:

A balance sheet that doesn’t balance. When the balance sheet doesn’t balance, warning bells should be going off in your head. No bookkeeper should ever give you a balance sheet that doesn’t work out. However, I’ve seen plenty of them.

If your bookkeeper can’t pass my bookkeeping test, he or she shouldn’t be doing books for your company. Anyone who doesn’t have the test and would like it, please e-mail me.

Negative payroll taxes payable. The likelihood that you overpaid your withholding taxes by thousands of dollars is almost impossible. If you see negative financial withholding on your balance sheet, then something was probably entered incorrectly.

Negative loan balances. Again, the likelihood that you paid more than the bank required to pay off your loan is slim to none. If you see negative loan balances on your balance sheet, then look for the entries that are wrong.

No rent or utility bills, or extremely high rents. This usually means that one month has double overhead expenses and another month has no overhead expenses. One month you earned a great profit without any expenses. Another month you earned no profit or were at a loss, which meant double overhead expenses. Both months’ financial statements are wrong. Make sure that the overhead that you expect in each month is there.

Inconsistent gross margins. If a department’s gross margin widely varies from month to month, the most likely cause is a sale in one month and expenses against that sale in another month. Make sure that you match sales and expenses in each month.

Learning to read your financial statements is like learning to use a new tool. But with practice, reading and understanding your financial statements become as easy as using that set of gauges. Keep practicing. You’ll soon get great at reading your scorecard and making the proper business decisions.

Copyright Ruth King. All rights reserved. Write to Ruth King, 1650 Oakbrook Drive, Suite 405, Norcross, GA 30093. Call (800) 511-6844; e-mail ruthking@hvacchannel.tv.