Accounting Questions to Ask
Questions for anyone who has to rely on a set of accounts without having prepared them: a manager reading a monthly pack, a small investor, a board member, or a student sitting with an accountant. They move from how the statements fit together to where the soft numbers are.
The questions
Open any question for the note
Which of the three statements do you look at first, and why that one?
Why ask it
Most experienced readers start with cash flow or the balance sheet rather than the profit line, and the reason they give is a short lesson in what they distrust. Anyone who only ever looks at profit is reading the most editable statement of the three.
In this business, where does the gap between profit and cash come from?
Why ask it
There is always a gap, and naming it tells you what kind of business you are looking at: stock sitting in a warehouse, customers paying late, or big upfront spending being spread over years. If the answer is that there is no gap, the numbers have probably not been compared.
Which ratios do you actually use here, and which do you ignore?
Why ask it
Textbook ratios are not all useful in every business, and the ones a practitioner ignores are informative. A software company watching inventory turns and a retailer ignoring gross margin would both be signs that the analysis is on autopilot.
How much of the profit figure depends on judgement rather than cash that moved?
Why ask it
Accruals, provisions, capitalised costs and revenue cut-off all rest on someone's call. A preparer who can quantify roughly how much of the result is judgement is being straight with you, and it tells you how much weight a single quarter can bear.
Which accounting policy choices here would another company make differently?
Why ask it
Two honest companies can report different profits on identical trading, mostly through revenue timing, depreciation lives and what gets capitalised. Knowing which choices were made is what makes a comparison with a competitor worth anything.
At what point does a sale count as revenue?
Why ask it
Order taken, goods shipped, service delivered and cash received can be months apart, and the choice moves the top line between periods. Watch for anything recognised well before the work is done, which is where restatements tend to originate.
What sits in working capital, and how long is cash tied up before it comes back?
Why ask it
The answer is the length of time the business has to fund itself, which is why a growing company can run out of money while profitable. If nobody tracks it as a number of days, growth is being financed by luck.
How is inventory valued, and what happens to the numbers if some of it has to be written down?
Why ask it
Stock sits on the balance sheet at cost until someone decides it will not sell, so a write-down hits profit in one lump with no cash movement. Slow-moving stock that has never been written down is a deferred problem rather than an asset.
Which costs stay exactly the same if sales halve next quarter?
Why ask it
This turns the cost lines into something useful: the fixed base the business has to cover before it earns anything. People often underestimate it, because leases, software contracts and salaried staff are less flexible than a budget spreadsheet suggests.
How were the depreciation lives set for the largest assets, and when were they last reviewed?
Why ask it
Lives are estimates, and stretching them lifts reported profit without changing anything real. An answer that dates back to a decision made years ago, for assets that have changed since, means the charge no longer reflects how the assets are used.
What is in other income and exceptional items this year?
Why ask it
These lines are where things get parked, and a recurring exceptional item is not exceptional. It is worth asking whether the same category appeared last year, because repeated one-offs usually belong in operating costs.
Which figures in this set are estimates that will be revised later?
Why ask it
Provisions, accrued income and any percentage-of-completion revenue will move. Knowing which they are tells you which parts of the report are provisional, and whether last year's estimates turned out close to the eventual outcome.
If something in these accounts were going wrong, where would it show up first?
Why ask it
Framed this way rather than as an accusation, it usually gets an honest answer: an ageing receivable, a customer concentration, a covenant getting tight. It also shows whether the preparer thinks about the numbers or only produces them.
How do the management accounts differ from the statutory ones?
Why ask it
Internal reporting often splits the business differently, excludes group charges, or uses a measure nobody outside would recognise. The differences are where the arguments happen, and understanding them stops you comparing two versions of the same year.
What does the trend look like over three years rather than one?
Why ask it
A single year hides seasonality and one-off events. Three years of the same lines usually reveals whether margins are drifting, and a preparer who cannot easily produce the comparison is telling you something about the reporting.
How much of the growth came from price, from volume, and from acquisitions?
Why ask it
Same revenue increase, three completely different businesses underneath. Growth that is all price may not survive a competitor, and growth by acquisition needs the cost of the deals set against it.
What did the auditors spend the most time on?
Why ask it
Auditors concentrate on the areas with the most judgement or the highest risk, so their attention is a free map of where the numbers are softest. A preparer who was in those conversations will remember them clearly.
What is owed, when is it due, and are there covenants attached?
Why ask it
A comfortable debt figure and an uncomfortable maturity date can sit in the same set of accounts. Covenants matter most because breaching one can make long-term debt repayable immediately, which changes the whole liquidity picture.
Which single number would you want to be certain of before relying on this report?
Why ask it
It forces a priority instead of a tour of the statements, and the number named is usually the one carrying the most estimation. That is where any verification effort should go first.
What would you need to see next period to change your view of this business?
Why ask it
A useful answer names a specific line and a threshold, which gives you something to check later. An answer that could not be falsified by any future result was an opinion, not analysis.
Reading a set of accounts you did not prepare
Practical guidance for the conversation itself
Before you start asking
Get all three statements, and the notes
A profit figure on its own cannot be checked. The notes are where policies, maturities, related parties and contingent liabilities are described, and they are usually the longest and least read part of the document.
Know which question is yours to ask
A bookkeeper can explain how a transaction was recorded. A financial controller can explain policy choices. Only the person who set the assumptions can explain a provision. Directing questions at the right person avoids answers that sound confident and mean nothing.
Say what decision you are making
Lending, buying, hiring and approving a budget need different parts of the same accounts. Stating the decision first lets the accountant point you at the numbers that matter and away from the ones that do not.
How to weigh the answers
- Ask for the arithmetic behind any figure you are told, once. If it cannot be produced, treat the figure as an estimate for now.
- Prefer answers that name a period and a number over answers that name a direction. Improving is not a quantity.
- Watch for the switch from statutory measures to adjusted ones mid-conversation. Adjusted figures are legitimate, but ask which costs were removed and why.
- Compare what you are told with the cash flow statement. Cash is the hardest line to present favourably.
- Write down the estimates you were given and check them against the next set of accounts. Estimation quality is the fastest way to judge whether reporting here is reliable.
Common mistakes readers make
Treating profit as cash
Profit can be reported in a period where nothing was collected, and a business can be short of cash while trading well. The two questions are separate and need to be asked separately.
Comparing companies without checking policies
Different revenue timing or depreciation lives can make one company look more profitable than another that trades identically. Compare the policies before comparing the margins.
Accepting a ratio without its inputs
A ratio can be moved by changing either side of it, and definitions vary between reports. Ask which figures went into the calculation before drawing anything from it.
Reading one year in isolation
Seasonality, a large contract, or a disposal can dominate a single period. Three years of the same lines tell you what is habitual and what was an event.