Having the right financial and tax strategy is the best way to help your business…
A company’s financial statements can give you valuable insight into their financial health. Each financial statement is a report that shows your business's financial activities and performance. Join the CPAs at C.E. Thorn, CPA, PLLC in Raleigh as they outline the three main types of financial statements, explain the key differences between consolidated financial statements and combined financial statements, and guide you on when to utilize each type in this post.
The Three Main Types of Financial Statements
The three primary types of financial statements are:
- Balance sheet - Shows the assets, liabilities, and capital of a business at a particular point in time, detailing the balance of income and expenditure over the preceding period
- Income statement - Shows the company’s income and expenditures as well as the profit or loss for a given period
- Cash flow statement - Shows how cash entered and exited a company during an accounting period
If you own a parent corporation, understanding the options available to your corporation when it comes to financial statements and reporting is critical. Knowing what the financial statements show about your corporation and the subsidiary companies the parent corporation controls means you will have greater comprehension and be a better corporate owner.
What Businesses Are Required to Have Financial Statements?
Both large and small businesses should have regularly updated financial statements. However, while some, such as small businesses, may not be required by law to have financial statements updated regularly, it pays dividends to have them when it comes to evaluating the overall financial health. It’s not only essential to learning the financial health of your business, but it provides valuable insight to shareholders and employees. Additionally, lenders, such as banks, may require a financial statement to vouch for your ability to repay a loan.
Publicly traded corporations, such as Google and Proctor & Gamble, are required to publish their financials regularly. The reason is that since they are publicly traded in the stock market, investors must be able to familiarize themselves with a company’s current financial situation to make sound investment decisions.
When tax season rolls around, all businesses must have financial statements prepared for tax purposes. So, if you’re a small business owner who hasn’t prepared and updated your financial statements throughout the year, this can be a big task. Having your financial statements updated throughout the year can ease your burden come tax season and may result in a lower tax preparation fee if your tax preparer doesn’t have to spend hours creating financial statements for the current tax year.
If you are a business owner who operates several different businesses with multiple subsidiaries, you can look at the data in two forms: consolidated financial statements or combined financial statements. Now, we will explain the difference between the two and help you know which will work best for your record-keeping purposes.
Combined Financial Statements
Combined financial statements are comprehensive documents that have liabilities, assets, earnings, and losses of a large corporation that constitutes many companies.
Understanding Combined Financial Statements
A combined financial statement reports the finances of the subsidiaries and parent company separately in one document. Within the document, all the parent’s and subsidiaries’ financial statements remain distinct.
If there are investors or potential investors, they can see how each company is doing. The parent and subsidiaries may include corporations and LLCs. All of the financials are easily seen for each one in a combined financial statement. It isn’t as apparent with a consolidated financial statement. If an investor wants to know how each subsidiary is doing, it is helpful for the investor to see a combined financial statement.
As an example, look at the PepsiCo company. PepsiCo owns Pepsi, Sierra Mist, Mountain Dew, Frito-Lay, Quaker, Tropicana, Naked Juice, and several smaller subsidiaries. With a combined financial statement, a person can see the individual results of each subsidiary of the parent company, PepsiCo.
Why Choose Combined Financial Statements
As stated earlier, investors who are interested in the financials of each operation of a parent company can get this information more easily in a combined financial statement. Combined financial statements are useful if one individual owns a controlling financial interest in several entities that are related to their operations.
Consolidated Financial Statements
Consolidated financial statements are the overall financial statements of any entity with multiple divisions. This includes the parent company and all subsidiaries that are controlled by the parent company.
Understanding Consolidated Financial Statements
Whereas a combined financial statement includes each subsidiary separately, a consolidated financial statement takes the financial results of the subsidiaries and includes them in a single financial statement for the parent company, as though the parent and subsidiaries are one entity. A consolidated financial statement reports on the enterprise as a whole with the parent and subsidiaries together making up the total financial picture of the entity.
An investor or potential investor can review a consolidated financial statement and see that the combined entity is financially sound because the statement shows the overall economic wealth of the parent company and its subsidiaries together. This allows the parent company to show how much money it controls. For example, if the parent company doesn’t bring in as much money as its subsidiaries, together the parent company and individual operations show how much more this conglomerate is worth than the parent company is worth alone.
Why Choose Consolidated Financial Statements
In the PepsiCo example, investors who are invested solely in PepsiCo may only be interested in the financials of PepsiCo, not the individual subsidiaries. The consolidation of the financial statements gives investors and lenders a clearer picture of how the corporation as a whole is performing and whether it is a safe investment.
Which Type of Financial Statement to Use
In general, it’s wise to solicit help from your financial advisor or tax preparer for their recommendation. However, when the parent company owns more than 50 percent of a subsidiary, you must file a consolidated financial statement. If you are a director of the parent corporation or LLC that is well known in the general public, and better known than the subsidiaries, consider filing a consolidated financial statement. The investor simply needs to know that the parent company is healthy and financially viable.
However, if it is more important to assess each entity on its own merits, rather than as part of a whole, then the combined financial statement may be more suitable. A combined financial statement is easier to prepare because it only requires a separate financial statement for each entity. Additionally, a combined statement is logical in the case where two or more entities are under common control, but there is no parent company.
In deciding which type of financial statement–either combined or consolidated–to prepare, much depends on the story you need to tell. You need to decide which is more important for you to portray a picture:
- Assessing the parent and subsidiaries as a whole, or
- Assessing the individual components.
Financial Statements for Small Businesses
Though this article has focused on large corporations, small businesses may also need combined and consolidated financial statements. If you have formed an LLC or have incorporated your small business, your financial statements must be shown to creditors, lenders, and the IRS with your tax returns. If you have multiple businesses that operate under the same LLC or corporation, you need consolidated or combined financial statements. For example, if you own a plumbing company and a plumbing supply shop, you may need either a consolidated or combined financial statement.
Contact C.E. Thorn, CPA, PLLC for Financial Statement Preparation in Raleigh
When it comes to choosing between consolidated financial statements and combined financial statements, it’s best to consult with your local CPA. After familiarizing themselves with your unique financial situation, your CPA can advise you on the best type of financial statement to use throughout the year. By choosing the best financial statement for your business, you may find tax season more manageable and a quicker process. If you’re a small business owner in the greater Raleigh area, C.E. Thorn, CPA, PLLC can prepare your financial statements throughout the year, taking the work off your plate when it comes to creating combined financial statements or consolidated financial statements. To get started, complete our contact form below or call our Raleigh office today at 919-420-0092.
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