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Breaking Down Financial Statement Footnotes

Posted by Nikki Layton on September 24, 2015 at 7:41 AM

If you’re handling your business’s accounting, you probably already know how important your financial statements are. They’re a key source of information on your company’s financial performance that can you help set your business on the right path for growth and success. Plus, these documents will definitely come under the microscope in the event that you ever get audited. (Knock on wood.) Auditors and investors won’t just be glancing casually over these statements. Instead, they’ll be looking at the fine print. So where do you find the “fine print” of your financial statements? In the footnotes.

 

What are Footnotes?

If you’ve ever written a formal academic paper or if you read articles and books that are on the more technical side, then you’ve already seen footnotes. They are those supplemental explanations found at the bottom of the page or section of text, usually written in a tiny font and containing information that would otherwise break up the flow of the main text. (For some of the most epic footnotes ever produced, Dave C. on our team suggests you read The Book of Basketball by Bill Simmons.) That said, the footnotes of your financial statements—whether it’s your income statement, balance sheet, or cash flow statement—take on a similar function. Financial statement footnotes provide additional information about the items presented in the main body of each statement, and can allow those who pore over the statement to do a more in-depth analysis of your company’s financial performance.

The primary goal of footnotes is to present and clarify your company’s accounting practices and reporting policies. This should be done in a clear and concise way, both to avoid confusion and to make it evident to those reading the statements that there is nothing suspicious going on in your business’s financial reporting.

What Information Goes in the Footnotes?

There’s an almost inexhaustible list of information that can be disclosed in the footnotes of your financial statements. It really depends on what industry your company is in and the size and scope of your business. There may be some industry-specific details you’ll want to include, while some details just won’t apply to you if you’re a smaller operation.

The two main areas of focus that will be featured in your footnotes have to do with 1) your company’s accounting methods and 2) explaining any major operational and financial results that have come up in the accounting period being reported on.

Any details pertaining to your accounting methods are generally listed first in the footnotes section, and can be broken up into separate areas of accounting, like inventory and revenues. The footnotes should lay out in clear terms how the company determines the value of each of these areas. For example, how is revenue recognized in your company’s accounting (i.e., when are the revenues from a sale recorded on your company’s books: at the moment the sale is made, or upon delivery of the goods to the customer)?

Some examples of other information that can be included in the footnotes are...

  • Account changes detailing any modifications in accounting principles that have occurred over the reporting period, a justification for these changes, and how they have impacted your accounts
  • Risks and uncertainties explaining any vulnerabilities faced by your business
  • Cash, specifically any uninsured cash balances on your books
  • Debt, including descriptive notes on any loans payable over the next five years, their interest rates, and maturities.

Who’s Reading the Footnotes and What are They Looking For?

As we mentioned above, any institution that is going to lend you money (i.e., a bank) is going to want to look into the “fine print” of your company’s financial statements, so the footnotes will definitely be of interest to them. And if your books are audited, the details found in the footnotes will matter, too.

Those who are reading the footnotes will be checking to see whether your company is following certain accounting standards—such as the Generally Accepted Accounting Principles (GAAP)—and other industry standards. If the information presented in the footnotes seems to indicate that your company’s accounting practices and policies deviate too much from the norm within your industry (or from general accounting standards), this will raise some red flags.

While you want to provide as much detail as necessary in the footnotes, there are no strict legal definitions of the minimum information you are required to disclose. A good practice is to avoid confusing or technical jargon, while making sure not to omit any important details about significant events or changes that have happened that may impact your company’s accounting. Anyone reading the fine print of your company’s financials should come away with a clearer understanding of your business’s reporting procedures, and be better able to gauge your financial standing.

Topics: Accounting