What Are Earnings?
By Jennifer Schiefert
A businesses’ earnings are a critical basis for most economic damage calculations, cash flow analyses and business valuations. However, determining the accurate amount of earnings is usually not as simple as pulling the net income figure from a company’s audited financial statements.
For starters, most companies do not have their financial statements audited. Audited financial statements are those in which a certified public accountant (CPA) has examined the statements and offers an opinion as to whether or not the financial statements are free from material misstatement and are presented fairly in conformity with generally accepted accounting principles. Alternatively, some companies have their financial statements either “reviewed” or “compiled” by CPAs. These engagements offer lesser degrees of assurance. For compilations, no opinion is given by the CPA; rather the accountant simply prepares financial statements based on the information provided by the company. For reviews, the accountant performs some analytical procedures, but not to the extent of those performed under an audit.
Of course, some companies do not have external accountants involved at all. In these instances, you are left with internally prepared financial statements and/or tax returns. Internal financial statements are only as good as the person entering the data. Accounting software, such as Quick- Books, can make the financial statements look credible with the click of a button, but if the information is not entered or coded properly to begin with, the financial statements can contain numerous and material errors. Finally, tax returns are signed under penalty of perjury so one would think they are reliable but oft en tax returns are subject to the same issues as internally prepared financial statements.
The following are three examples of how earnings could be misstated.