Look at the footnotes in financial statements to safeguard your investing dollars

Posted on Oct 23, 2014

By Pete Miller, CPA, CFE

The case I’m examining today has not ventured into the legal arena as fraud.  However, it yields a valuable lesson because it stresses the power of the information contained in the footnotes in financial statements.

In my humble opinion, the footnotes that accompany basic financial statements are the most valuable components of an audited set of financial statements.  The footnotes contain details that aren’t apparent from just looking at the numbers, and they also include qualitative information that inherently won’t be included in the basic financial statements.

From this article, we learn that a publicly traded company entered into several real estate commitments that allegedly involved “corporate facilities.”  However, we later learn that those corporate facilities represented the CEO and majority shareholder’s personal residence.

Purchase commitments and related party transactions are two items that may only be highlighted in the footnotes.   When a company enters into transactions with owners or other related parties, the existence of those transactions and the dollar amounts are required to be disclosed in the footnotes.  In addition, if a company enters into an agreement that commits them to a major purchase (as was the case here), whether it involves a related party or not, that is also required to be disclosed.  At a minimum, a potential investor in Bill the Butcher would have learned of these transactions by reading the footnotes.

In this case, the existence of the financial commitment for these “facilities” was just scratching the surface of the valuable information in the footnotes.  If you look at the 10-K filling for Bill the Butcher, you will find some very interesting information in the notes.  If someone was interested in making an investment in this company, or if a bank was interested in underwriting a line of credit, the following footnotes would have been very useful for them:

  • Code of Ethics – We have not adopted a Code of Ethics for the Board and any employees as we currently only have a single director and executive officer.
  • Corporate Governance – We currently have no standing audit, compensation or nominating committees of committees performing similar functions, nor do we have written audit, compensation or nominating committee charters.
  • Our principal shareholder has significant influence over matters subject to shareholder vote and may support corporate actions that conflict with other shareholders’ interests.

These are very thought-provoking statements and likely represent important information you would rather have if you were making a meaningful investment decision about this company.

When reading financial statements, don’t stop reading once you get to the end of the cash flow statement; the footnotes are when the story starts to get good.

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