25. Three Reasons Managers Misread Financial Reports

SUMMARY

Three Reasons Managers Misread Financial Reports

Here are three reasons managers misread their financial reports. By not interpreting the financial report can lead to bad decisions and results.

Transcription

Let's have a look at financial reports and how sometimes they are misinterpreted by managers. 'Cause managers, well, most people do not live in the same world as accountants.

And so one of the first ways that I found when talking with managers in many of my jobs and also as my role as a business coach is sitting down with managers and going through their financial statements. And these are some of the things where they're being misinterpreted. And one of them is that the reports are a hundred percent accurate. And now accounting is like a science where accounting is at times more of an art and even when you're sitting down with accountants, they all have different beliefs over the way that the accounts should be prepared.

And so when I'm talking about that, sometimes when I'm talking with managers they're like, "Well the accounts have been ordered, 'so they must be 100% correct". And that sometimes is not the case, 'cause auditors when they come in and they audit the business, they are looking at the whole of the business, and the reports that the managers are getting are for different cost centres. And so while the reports are being approved by the auditor from a whole perspective, sometimes the report for the cost centre is not correct. And some of those things can be wages are not being allocated to the right areas, or income is not being put into the right areas or they are being miscoded. So your reports are only as accurate as your systems that you have in place, the decisions that are being made by your bookkeepers or your accountants, and those sort of things.

So it's important to understand the assumptions that are also going under your report. And I'll be talking about that in the next video about assumptions. The second area that people sort of get confused is cash versus accrual. And cash versus accrual is really comes down to a timing difference. So in the cash method of accounting, when money goes in or when money goes out, that's when it's accounted for. So when someone pays you for the invoice, so your bank's gone up $100, then your sales would go up $100. And so it's not accounted for until then, where if you're using the accrual system, once the invoice has been sent out, so you send an invoice out for $100, so then going into your income statement is $100, but you haven't been paid. You may be paid two months down the track.

So really the big difference between cash and accrual is timing. It's all going to come out to exactly the same if you stopped within a certain period and everything was paid. But accrual, accountants like to use accrual because you are trying to match income with your expenses. And so that's why accountants like to use the accrual method is so you're matching income against expenses to see whether that activity that you've just done is actually profitable.

And so many times assumptions that are being made about when is income actually coming into the business. So when a sales person believes the sale should come into the accounts, it generally is very different to the way the accountant thinks it should come into the accounts. And so sometimes we have businesses getting themselves into trouble because they are bringing income in earlier to either satisfy shareholders or satisfy board members.

And there was a case going back quite a few years, I think it was Xerox, and they brought forward $5 billion worth of income, so what they were doing is they were selling their fax machines or their photocopiers and then having a two year maintenance contract. And so what they were doing was they were pushing that income for the two years forward into the first month, making things look really good, which is really a short term solution, because in two years' time, unless you're creating a sort of pyramid scheme, your books are going to fall into a heap and that's what happened. But that happens in small businesses to big businesses. 

Lastly when working with managers, some managers are scared. They're scared of the numbers that they don't understand or their math isn't very good, or that sort of thing. But you don't have to be a mathematician, you don't have to be good at math, you just need to understand the important, the critical parts of your numbers. And so by doing that I recommend you have a system and you have a checklist. And if you do that it will relieve some of the stress of what you are doing when you are looking at the numbers.

Like we have systems for every other part of their business why don't we have a system for reviewing our financial reports. And then on having a checklist, like okay, my sales growth is fine, and you're just going through. On the other scale is people who are overconfident. So managers who think they know the numbers and they're making assumptions which don't line up with what accountants do. And then they're making mistakes because they are overconfident, and they are making false assumptions.

So these are three ways that I've come across from working with managers when financial reports are being misinterpreted. So thank you very much, and I'll see you in the next video.

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