Notes on looking at a Financial Statement

Here are some things to watch out for when we look at financials these guys give us:

We are interested in learning the p/l of the business normalized for a certain reporting period that includes any seasonality.

Revenues- need to make sure they are not counting prepaid revenues for periods outside our audit. For example, maybe they have a program that says if they pay early they get a discount. Or they book revenues but they have an account for doutbtful collections. They could be pumping the top line since some business are multiples of sales (motels). You pump sales by $1 and increase $1 for doubtbul accounts but then you get $3 (3x of sales) on the selling price! Any refunds or any clauses like that must also be accounted for. We have to look at their agreements to check for consitency.

Expenses- we need to make sure they didnt prepay expenses in an earlier year so that the earnings report we look at overstates the income. Prop tax might be prepaid in advance, certain educational materials, if legal risk is there like it is with day care then we should be building a reserve against it.

Other expenses - need to make sure they are not recurring expenses. Sometimes they will take 'one time' charges but really they are recurring and should be moved above the line (into operating expenses).

Future Cap Ex- we can think about what needs to be taken out periodically.

Balance sheet- overstatement of assets...this will deal with the real estate valuation...generally with long term assets you take a writedown if the book value > pv of cash flows you get on the asset. We should writedown the asset if need be. We also have to see if the depreciation expense / residual value is reasonable on the income statement side, otherwise we will take a writedown in a future period. This writedown hits our shareholders equity directly!