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Financial statements aren\u2019t particularly meaningful without a relevant basis of comparison. There are two types of \u201cbenchmarks\u201d that a company\u2019s financials can be compared to \u2014 its own historical performance and the performance of other comparable businesses.<\/p>\n
Before you conduct a benchmarking study, however, it\u2019s important to make normalizing adjustments to avoid any misleading comparisons. This is especially important when looking at periods that include atypical financial results due to the novel coronavirus (COVID-19) pandemic. But there are a variety of factors that require normalizing adjustments.<\/p>\n
Nonrecurring items<\/strong><\/p>\n Some normalizing adjustments are needed to distinguish between historical results that represent potential ongoing earning power and those that don\u2019t. A one-time revenue (or expense) or gain (or loss) will temporarily distort the company\u2019s results. To more accurately reflect the company\u2019s future earnings potential, you would add back expenses and losses (or subtract the revenues and gains) that aren\u2019t expected to recur.<\/p>\n For example, if a retailer temporarily closed its brick-and-mortar stores during the COVID-19 pandemic, you\u2019d add back the temporary losses to get a clearer picture of operating performance under normal conditions. Likewise, if a company won a $10\u00a0million lawsuit, you\u2019d subtract the gain. Other nonrecurring items might include discontinued product lines or expenses incurred in an acquisition.<\/p>\n Accounting norms<\/strong><\/p>\n Other normalizing adjustments compensate for the use of different accounting methods. Because companies\u2019 accounting practices vary widely, comparing them without adjusting their financial statements is like comparing apples to oranges.<\/p>\n Even within the broad confines of Generally Accepted Accounting Principles (GAAP), it\u2019s rare for two companies to follow exactly the same accounting practices. When comparing a company\u2019s results to industry benchmarks, you need to understand how they report transactions.<\/p>\n A small firm, for example, might report earnings when cash is received (cash basis accounting), but its competitor might record a sale when it sends out the invoice (accrual basis accounting). Differences in inventory reporting, pension reserves, depreciation methods, tax accounting practices and cost capitalization vs. expensing policies also are common.<\/p>\n Related-party transactions<\/strong><\/p>\n Another type of normalizing adjustment focuses on closely held businesses. They often pay owners based on the company\u2019s cash flow or the owners\u2019 personal needs, not on the market value of services the owners provide. Small businesses also may employ family members, conduct business with affiliates and extend loans to company insiders.<\/p>\n To get a clearer picture of the company\u2019s performance, you\u2019ll need to identify all related-party transactions and inquire whether they occur at \u201carm\u2019s length.\u201d Also consider reconciling for unusual perquisites provided to insiders, such as season tickets to sporting events, college tuition or company vehicles.<\/p>\n We can help<\/strong><\/p>\n To complicate matters, normalizing adjustments can affect multiple accounts. While most normalizing adjustments are made to the income statement, some may flow through to the balance sheet. Our accounting professionals can help with these critical adjustments to a company\u2019s financial statements, enabling you to make better-informed business decisions.<\/p>\n \u00a9 2020<\/em><\/p>\n <\/body> Financial statements aren\u2019t particularly meaningful without a relevant basis of comparison. There are two types of \u201cbenchmarks\u201d that a company\u2019s financials can be compared to \u2014 its own historical performance and the performance of other comparable businesses. Before you conduct a benchmarking study, however, it\u2019s important to make normalizing adjustments to avoid any misleading comparisons. […]<\/p>\n","protected":false},"author":3,"featured_media":14650,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[13],"tags":[],"class_list":["post-14651","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-aa"],"_links":{"self":[{"href":"https:\/\/www.sfw.cpa\/news-and-guides\/wp-json\/wp\/v2\/posts\/14651","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.sfw.cpa\/news-and-guides\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.sfw.cpa\/news-and-guides\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.sfw.cpa\/news-and-guides\/wp-json\/wp\/v2\/users\/3"}],"replies":[{"embeddable":true,"href":"https:\/\/www.sfw.cpa\/news-and-guides\/wp-json\/wp\/v2\/comments?post=14651"}],"version-history":[{"count":0,"href":"https:\/\/www.sfw.cpa\/news-and-guides\/wp-json\/wp\/v2\/posts\/14651\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/www.sfw.cpa\/news-and-guides\/wp-json\/"}],"wp:attachment":[{"href":"https:\/\/www.sfw.cpa\/news-and-guides\/wp-json\/wp\/v2\/media?parent=14651"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.sfw.cpa\/news-and-guides\/wp-json\/wp\/v2\/categories?post=14651"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.sfw.cpa\/news-and-guides\/wp-json\/wp\/v2\/tags?post=14651"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}
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