INSIDE INVESTOR: A short-cut to spotting balance sheet problems

Most of the time the auditor's statement accompanying a business' financial report is bland, but it's essential to read as it occasionally yields an absolute revelation about the company's outlook.

By Ian Verrender ·
12 Mar 2013

You probably know that old Monty Python skit about accountants and auditors, how most of them really want to do something exciting with their lives like being a lion tamer.

It is a sure bet the Python crew have a whole slew of accountants these days to manage their financial affairs.

And with good reason. Auditors play a vital role in business and those company accounts that are sent to you each year – and in some cases each six months – contain a wealth of information, if you’ll pardon the pun.

The annual accounts need to be accepted for what they really are; a snapshot of the financial situation of the company at a particular second of a particular minute on June 30, the end of the financial year.

The numbers contained on the balance sheet are constantly changing as sales accelerate or decrease, as interest rates rise or fall or as the company expands or shrinks its operations.

So a balance sheet does have its limitations. That doesn’t mean it should be ignored.

Read through what the chairman and chief executive have to say at the beginning. Even though it will contain a positive spin on events and plans, it will still give you a good indication of where the company has been and where it may be headed.

Don’t stop there. Even if you find the accounts themselves a complex puzzle, look towards the back of the book to the section marked Auditor’s Report or Auditor’s Statement.

If there is one page in the annual report you should read, it is that page. It is an absolute must.

In most cases, it will simply have a bland statement that the accounts have been checked and everything appears in order.

Occasionally though, there can be some absolute revelations, either about suspect dealings by executives or directors or, in the worst case scenario, that the company remains trading only because its lenders remain supportive. That’s code for “debt problems”.

This is when that submarine warning should start sounding, red lights begin flashing and you should be having third thoughts about whether it is time to abandon ship. Always remember, shareholders stand last in line in the event of a company collapse.

It may well be that you are comfortable with that risk, that you believe the company can ride through its problems and that you will make a handy profit when conditions improve. As long as you are aware of the risk.