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This piece is the first in a series that will look at accounting issues for investors, pointing out the areas on which investors should focus in plain man’s English. It springs from a presentation made by Mike Foster, one of Hardman’s team of analysts, at the recent Mello event in Peterborough. Since this is the introductory article to the Hardman Monthly its length is restricted. Hence we aim to tackle only a few issues in each piece.
Have you ever heard of the auditors? Often the treatment of items in a set of accounts is subject to debate between the company and its auditors – there is room for negotiation. If you are one of the large auditing firms your reputation is key and each client is probably not a significant part of your revenue, thus you are unlikely to be bullied by management. However, if you are a small local auditing firm, and one of your clients has grown from a small business to a nationally significant one, then this client is critical for two reasons. Firstly, it will be a big part of your revenues and, secondly, you probably use its name in your pitches and marketing. The result is that you would be loath to lose it and hence more ‘pliable’ to management demands.
Have they changed auditors recently? Of course there are lots of reasons for a change which would not cause a concern to investors, but sometimes it stems from an argument over the treatment of items in the accounts between management and auditors, not a good sign. Neither side is likely ever to flag that up as a reason for the change, but investors should always think carefully about a change.
Have they changed accounting dates? Again there are some perfectly valid reasons for changing a year end. For example, the shape of the business could have changed. A manufacturing business could have reversed into a larger retailer where Christmas is key; it might make sense to move from a September to a December year end. But once more investors should start from a position on suspicion. Do also note that – quite legitimately – the balance sheet date will see various accounting ratios at levels which might not reflect the average in the year. Debt is often somewhat different with trade debtors accounts looked at particularly closely over the year end. Some businesses are more seasonal than others.
Read the Notes to the accounts. These are as important as the main tables and often repay careful consideration. Note that they will usually only be published with the full Report and Accounts, not at the initial publication of the results on the stock market. Reading the Report and Accounts is essential, as often the Notes are either interesting or absolutely crucial in pointing to some very material facts about the business.