15,99 €
Mehr erfahren.
- Herausgeber: John Wiley & Sons
- Kategorie: Ratgeber
- Sprache: Englisch
- Veröffentlichungsjahr: 2013
Discover how to decipher financial reports Especially relevant in today's world of corporate scandals andnew accounting laws, the numbers in a financial report containvitally important information about where a company has been andwhere it is going. Packed with new and updated information, Reading FinancialReports For Dummies, 3rd Edition gives you a quick but clearintroduction to financial reports-and how to decipher theinformation in them. * New information on the separate accounting and financialreporting standards for private/small businesses versuspublic/large businesses * New content to match SEC and other governmental regulatorychanges * New information about how the analyst-corporate connection hasactually changed the playing field * The impact of corporate communications and newtechnologies * New examples that reflect current trends * Updated websites and resources Reading Financial Reports For Dummies is for investors,traders, brokers, managers, and anyone else who is looking for areliable, up-to-date guide to reading financial reportseffectively.
Sie lesen das E-Book in den Legimi-Apps auf:
Seitenzahl: 578
Ähnliche
Reading Financial Reports For Dummies®, 3rd Edition
Published by: John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030-5774, www.wiley.com
Copyright © 2014 by John Wiley & Sons, Inc., Hoboken, New Jersey
Published simultaneously in Canada
No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning or otherwise, except as permitted under Sections 107 or 108 of the 1976 United States Copyright Act, without the prior written permission of the Publisher. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online at http://www.wiley.com/go/permissions.
Trademarks: Wiley, For Dummies, the Dummies Man logo, Dummies.com, Making Everything Easier, and related trade dress are trademarks or registered trademarks of John Wiley & Sons, Inc., and may not be used without written permission. All other trademarks are the property of their respective owners. John Wiley & Sons, Inc., is not associated with any product or vendor mentioned in this book.
LIMIT OF LIABILITY/DISCLAIMER OF WARRANTY:WHILE THE PUBLISHER AND AUTHOR HAVE USED THEIR BEST EFFORTS IN PREPARING THIS BOOK, THEY MAKE NO REPRESENTATIONS OR WARRANTIES WITH RESPECT TO THE ACCURACY OR COMPLETENESS OF THE CONTENTS OF THIS BOOK AND SPECIFICALLY DISCLAIM ANY IMPLIED WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE. NO WARRANTY MAY BE CREATED OR EXTENDED BY SALES REPRESENTATIVES OR WRITTEN SALES MATERIALS. THE ADVICE AND STRATEGIES CONTAINED HEREIN MAY NOT BE SUITABLE FOR YOUR SITUATION. YOU SHOULD CONSULT WITH A PROFESSIONAL WHERE APPROPRIATE. NEITHER THE PUBLISHER NOR THE AUTHOR SHALL BE LIABLE FOR DAMAGES ARISING HEREFROM.
For general information on our other products and services, please contact our Customer Care Department within the U.S. at 877-762-2974, outside the U.S. at 317-572-3993, or fax 317-572-4002. For technical support, please visit www.wiley.com/techsupport.
Wiley publishes in a variety of print and electronic formats and by print-on-demand. Some material included with standard print versions of this book may not be included in e-books or in print-on-demand. If this book refers to media such as a CD or DVD that is not included in the version you purchased, you may download this material at http://booksupport.wiley.com. For more information about Wiley products, visit www.wiley.com.
Library of Congress Control Number: 2013918697
ISBN 978-1-118-76193-9 (pbk); ISBN 978-1-118-77502-8 (ebk); ISBN 978-1-118-77506-6 (ebk); ISBN 978-1-118-77516-5 (ebk)
Manufactured in the United States of America
10 9 8 7 6 5 4 3 2 1
Reading Financial Reports For Dummies®, 3rd Edition
Visit www.dummies.com/cheatsheet/readingfinancialreports to view this book's cheat sheet.
Table of Contents
Introduction
About This Book
Conventions Used in This Book
What You're Not to Read
Foolish Assumptions
Icons Used in This Book
Beyond the Book
Where to Go from Here
Part I: Getting Started with Reading Financial Reports
Chapter 1: Opening the Cornucopia of Reports
Figuring Out Financial Reporting
Preparing the reports
Seeing why financial reporting counts (and who's counting)
Checking Out Types of Reporting
Keeping everyone informed
Following the rules: Government requirements
Going global
Staying within the walls of the company: Internal reporting
Dissecting the Annual Report to Shareholders
Breaking down the parts
Getting to the meat of the matter
Keeping the number crunchers in line
Chapter 2: Recognizing Business Types and Their Tax Rules
Flying Solo: Sole Proprietorships
Keeping taxes personal
Reviewing requirements for reporting
Joining Forces: Partnerships
Partnering up on taxes
Meeting reporting requirements
Seeking Protection with Limited Liability Companies
Taking stock of taxes
Reviewing reporting requirements
Shielding Your Assets: S and C Corporations
Paying taxes the corporate way
Getting familiar with reporting requirements
Chapter 3: Public or Private: How Company Structure Affects the Books
Investigating Private Companies
Checking out the benefits
Defining disadvantages
Figuring out reporting
Understanding Public Companies
Examining the perks
Looking at the negative side
Filing and more filing: Government and shareholder reports
Entering a Whole New World: How a Company Goes from Private to Public
Teaming up with an investment banker
Making a public offering
Chapter 4: Digging into Accounting Basics
Making Sense of Accounting Methods
Cash-basis accounting
Accrual accounting
Why method matters
Understanding Debits and Credits
Double-entry accounting
Profit and loss statements
The effect of debits and credits on sales
Depreciation and amortization
Checking Out the Chart of Accounts
Asset accounts
Liability accounts
Equity accounts
Revenue accounts
Expense accounts
Differentiating Profit Types
Gross profit
Operating profit
Net profit
Part II: Checking Out the Big Show: Annual Reports
Chapter 5: Exploring the Anatomy of an Annual Report
Everything but the Numbers
Debunking the letter to shareholders
Making sense of the corporate message
Meeting the people in charge
Finding basic shareholder information
Getting the skinny from management
Getting guarantees from management
Bringing the auditors’ answers to light
Presenting the Financial Picture
Summarizing the Financial Data
Finding the highlights
Reading the notes
Chapter 6: Balancing Assets against Liabilities and Equity
Understanding the Balance Equation
Introducing the Balance Sheet
Digging into dates
Nailing down the numbers
Figuring out format
Ogling Assets
Current assets
Long-term assets
Accumulated depreciation
Looking at Liabilities
Current liabilities
Long-term liabilities
Navigating the Equity Maze
Stock
Retained earnings
Capital
Drawing
Chapter 7: Using the Income Statement
Introducing the Income Statement
Digging into dates
Figuring out format
Delving into the Tricky Business of Revenues
Defining revenue
Adjusting sales
Considering cost of goods sold
Gauging gross profit
Acknowledging Expenses
Sorting Out the Profit and Loss Types
EBITDA
Nonoperating income or expense
Net profit or loss
Calculating Earnings per Share
Chapter 8: The Statement of Cash Flows
Digging into the Statement of Cash Flows
The parts
The formats
Checking Out Operating Activities
Depreciation
Inventory
Accounts receivable
Accounts payable
The cash flow from activities section, summed up
Investigating Investing Activities
Understanding Financing Activities
Issuing stock
Buying back stock
Paying dividends
Incurring new debt
Paying off debt
Recognizing the Special Line Items
Discontinued operations
Foreign currency exchange
Adding It All Up
Chapter 9: Scouring the Notes to the Financial Statements
Deciphering the Small Print
Accounting Policies Note: Laying out the Rules of the Road
Depreciation
Revenue
Expenses
Figuring out Financial Borrowings and Other Commitments
Long-term obligations
Short-term debt
Lease obligations
Mergers and Acquisitions: Finding Noteworthy Information
Pondering Pension and Retirement Benefits
Breaking Down Business Breakdowns
Reviewing Significant Events
Finding the Red Flags
Finding out about valuing assets and liabilities
Considering changes in accounting policies
Decoding obligations to retirees and future retirees
Chapter 10: Considering Consolidated Financial Statements
Getting a Grip on Consolidation
Looking at Methods of Buying up Companies
Reading Consolidated Financial Statements
Looking to the Notes
Mergers and acquisitions
Goodwill
Liquidations or discontinued operations
Part III: Analyzing the Numbers
Chapter 11: Testing the Profits and Market Value
The Price/Earnings Ratio
Figuring out earnings per share
Calculating the P/E ratio
Practicing the P/E ratio calculation
Using the P/E ratio to judge company market value (stock price)
Understanding variation among ratios
The Dividend Payout Ratio
Determining dividend payout
Digging into companies’ profits with dividends
Return on Sales
Figuring out ROS
Reaching the truth about profits with ROS
Return on Assets
Doing some dividing to get ROA
Ranking companies with the help of ROA
Return on Equity
Calculating ROE
Reacting to companies with ROEs assistance
The Big Three: Margins
Dissecting gross margin
Investigating operating margin
Catching the leftover money: Net profit margin
Chapter 12: Looking at Liquidity
Finding the Current Ratio
Calculating the current ratio
What do the numbers mean?
Determining the Quick Ratio
Calculating the quick ratio
What do the numbers mean?
Investigating the Interest Coverage Ratio
Calculating the interest coverage ratio
What do the numbers mean?
Comparing Debt to Shareholders’ Equity
Calculating debt to shareholders’ equity
What do the numbers mean?
Determining Debt-to-Capital Ratio
Calculating the debt-to-capital ratio
What do the numbers mean?
Chapter 13: Making Sure the Company Has Cash to Carry On
Measuring Income Success
Calculating free cash flow
Figuring out cash return on sales ratio
Checking Out Debt
Determining current cash debt coverage ratio
Computing cash debt coverage ratio
Calculating Cash Flow Coverage
Finding out the cash flow coverage ratio
Mattel
Hasbro
What do the numbers mean?
Part IV: Understanding How Companies Optimize Operations
Chapter 14: How Reports Help with Basic Budgeting
Peering into the Budgeting Process
Understanding who does what
Setting goals
Building Budgets
Providing Monthly Budget Reports
Using Internal Reports
Chapter 15: Turning Up Clues in Turnover and Assets
Exploring Inventory Valuation Methods
Applying Three Inventory Valuation Methods
Average costing
FIFO
LIFO
How to compare inventory methods and financial statements
Determining Inventory Turnover
Calculating inventory turnover
What do the numbers mean?
Investigating Fixed Assets Turnover
Calculating fixed assets turnover
What do the numbers mean?
Tracking Total Asset Turnover
Calculating total asset turnover
What do the numbers mean?
Chapter 16: Examining Cash Inflow and Outflow
Assessing Accounts Receivable Turnover
Calculating accounts receivable turnover
What do the numbers mean?
Taking a Close Look at Customer Accounts
Finding the Accounts Payable Ratio
Calculating the ratio
What do the numbers mean?
Determining the Number of Days in Accounts Payable
Calculating the ratio
What do the numbers mean?
Deciding Whether Discount Offers Make Good Financial Sense
Calculating the annual interest rate
What do the numbers mean?
Chapter 17: How Companies Keep the Cash Flowing
Slowing Bill Payments
Speeding Up Collecting Accounts Receivables
Borrowing on Receivables
Reducing Inventory
Getting Cash More Quickly
Part V: The Many Ways Companies Answer to Others
Chapter 18: Finding Out How Companies Find Errors: The Auditing Process
Inspecting Audits and Auditors
Looking for mistakes
Meeting Mr. or Ms. Auditor
Examining Records: The Role of the Auditor
Preliminary review
Fieldwork
Audit report
Filling the GAAP
Accounting standards: Four important qualities
Changing principles: More work for the FASB
Chapter 19: Digging into Government Regulations
Checking Out the 10-Q
Financial information
Other critical matters
Introducing the 10-K
Business operations
Financial data
Information about directors and executives
The extras
Investigating Internal Controls
Uncovering the Ways Companies Keep in Compliance
Digging into Board Operations
Understanding the nominating process
Contacting board members
Finding Out about Insider Ownership
Chapter 20: Creating a Global Financial Reporting Standard
Why Develop a Worldwide Financial Standard?
Key Moves to Reshape Global Financial Reporting
Who Benefits from a Global Standard and How?
Investors
Capital Markets
Companies
Key Differences between GAAP and the IFRS
Accounting framework
Financial statements
Revenue recognition
Assets
Inventory
Related-party transactions disclosures
Discontinued operations
Impairment charges
Chapter 21: Checking Out the Analyst–Corporation Connection
Typecasting the Analysts
Buy-side analysts
Sell-side analysts
Independent analysts
Bond analysts
Regarding Bond-Rating Agencies
Delving into Stock Rating
Taking a Look at How Companies Talk to Analysts
Analyst calls
Press releases
Mobile apps
Road shows
Chapter 22: How Companies Communicate with Shareholders
Making the Most of Meetings
Checking Out How the Board Runs the Company
Watching the directors
Speaking out at meetings
Moving away from duking it out
Sorting through Reports
Catching Up on Corporate Actions
Culling Information from Analyst Calls
Listening between the lines
Knowing when to expect analyst calls
Staying Up-to-Date Using Company Websites
Regarding Reinvestment Plans
Dividend reinvestment plans
Direct stock purchase plans
Chapter 23: Keeping Score When Companies Play Games with Numbers
Getting to the Bottom of Creative Accounting
Defining the scope of the problem
Seeing through cooked books
Unearthing the Games Played with Earnings
Reading between the revenue lines
Detecting creative revenue accounting
Exploring Exploitations of Expenses
Advertising expenses
Research and development costs
Patents and licenses
Asset impairment
Restructuring charges
Finding Funny Business in Assets and Liabilities
Recognizing overstated assets
Looking for undervalued liabilities
Playing Detective with Cash Flow
Discontinued operations
Income taxes paid
Part VI: The Part of Tens
Chapter 24: en (+1) Financial Scandals That Rocked the World
Enron
Madoff
Citigroup
Adelphia
WorldCom/MCI
Sunbeam
Tyco
Waste Management
Bristol-Meyers Squibb
Halliburton
Arthur Andersen
Chapter 25: Ten Signs That a Company's in Trouble
Lower Liquidity
Low Cash Flow
Disappearing Profit Margins
Revenue Game Playing
Too Much Debt
Unrealistic Values for Assets and Liabilities
A Change in Accounting Methods
Questionable Mergers and Acquisitions
Slow Inventory Turnover
Slow-Paying Customers
Glossary
About the Authors
Cheat Sheet
More Dummies Products
Guide
Table of Contents
Begin Reading
Pages
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
41
42
43
44
45
46
47
48
49
50
51
52
53
54
55
56
57
58
59
60
61
62
63
64
65
66
67
68
69
70
71
72
73
74
75
76
77
78
79
80
81
82
83
84
85
86
87
88
89
90
91
92
93
94
95
96
97
98
99
100
101
102
103
104
105
106
107
108
109
110
111
112
113
114
115
116
117
119
120
121
122
123
124
125
126
127
128
129
130
131
132
133
134
135
149
150
151
152
153
154
155
156
157
158
159
160
161
162
163
164
165
166
167
168
169
170
171
172
173
174
175
176
177
178
179
180
181
182
183
184
185
186
187
188
189
190
191
192
193
194
195
196
197
198
199
200
201
202
203
204
205
206
207
208
209
210
211
212
213
214
215
216
217
218
219
220
221
222
223
224
225
226
227
228
229
230
231
233
234
235
236
237
238
239
240
241
242
243
245
246
247
248
249
250
251
252
253
254
255
256
257
258
259
260
261
262
263
264
265
266
267
268
269
270
271
272
273
274
275
276
277
279
280
281
282
283
284
285
286
287
288
289
290
291
292
293
294
295
296
297
298
299
300
301
302
303
304
305
306
307
308
309
310
311
312
313
314
315
316
317
318
319
320
321
322
323
324
325
327
328
329
330
331
332
333
334
335
336
337
338
339
340
361
363
364
Introduction
When I open an annual financial report today, one of the first questions I ask myself is, “Can I believe the numbers I'm seeing?” I never used to think that way. I used to think that any corporate financial report audited by a certified public accountant truly was prepared with the public's interests in mind.
The financial scandals of the late 1990s and early 2000s destroyed my confidence in those numbers, as they did for millions of other U.S. investors who lost billions in the stock market crash that followed those scandals. Sure, a stock bubble (a period of rising stock prices that stems from a buying frenzy) had burst, but financial reports that hid companies’ financial problems fueled the bubble and helped companies put on a bright, smiling face for the public. After these financial reporting scandals came to light, more than 500 public companies had to restate their earnings. Yet in almost a repeat of the scandals, the mortgage mess of 2007 showed how financial institutions were still using the same tricks of keeping key financial information off the books to hide financial troubles.
I still wonder what government regulators and public accountants were thinking and doing during these fiascos. How did the system break down so dramatically and so quickly? Although a few voices raised red flags, their pleas were drowned out by the euphoria of the building stock market bubble of the early 1990s and the housing market bubble of the mid-2000s.
These financial scandals occurred partly because Wall Street measures success based on a company's quarterly results. Many analysts on Wall Street are more concerned about whether a company meets its quarterly expectations than they are about a company's long-term prospects for future growth. Companies that fail to meet their quarterly expectations find their stock quickly beaten down on the market. To avoid the fall, companies massage their numbers. This shortsighted race to meet the numbers each quarter is a big reason these scandals happen in the first place.
Since the scandals broke, legislators have enacted new laws and regulations to attempt to correct the problems. In this book, I discuss these new regulations and show you how to read financial reports with an ounce of skepticism and a set of tools that can help you determine whether the numbers make sense. I help you see how companies can play games with their numbers and show you how to analyze the numbers in a financial report so you can determine a company's true financial health.
About This Book
This book provides detailed information on how to read a financial report's key statements — the balance sheet, the income statement, and the statement of cash flows — as well as how to discover and scour a report's other important parts.
When you finish reading this book, you'll understand what makes up the parts of financial statements and how to read between their lines, using the fine print to increase your understanding of a company's financial position. You'll also be familiar with the company outsiders who are responsible for certifying the accuracy of financial reports, and you'll know how the rules have changed since the corporate scandals broke. Although I can't promise that you'll be able to detect every type of fraud, I can promise that your antennae will be up and you'll be more aware of how to spot possible problems. And most important, you'll get a good understanding of how to use these reports to make informed decisions about whether a company is a sound investment. If you work inside a company, you'll have a better understanding of how to use the reports to manage your company or your department for success.
Conventions Used in This Book
I use the words corporation and company almost interchangeably. Just so we're on the same page, all corporations are companies, but not all companies are corporations. The key difference between them is whether a company has gone through incorporation, which is the rather complicated legal process by which a company gets a state charter to operate as a business. To find out more about company structure and incorporation, see Chapter 2.
To help you practice the tools I show you in this book, I use the annual reports of the two largest toy companies, Mattel and Hasbro, and dissect their reports throughout various chapters. You can download a full copy of the reports by visiting the investor relations section of the companies’ websites: www.hasbro.com and www.mattel.com.
What You're Not to Read
Many of the topics I discuss in this book are, by nature, technical — dealing with finances can hardly be otherwise. But in some cases, I provide details that offer more than the basic stuff you need to know to understand the big picture. Because these explanations may not be up your alley, I mark them with a Technical Stuff icon (see the upcoming section “Icons Used in This Book”) and invite you to skip them without even the slightest regret. Even if you skip them, you still get all the information you need. On the other hand, if you savor every financial detail or fancy yourself the bravest of all financial report readers, then dig in!
I've also added some sidebars to give you more detail about a topic or some financial history. You can skip those, too, and still be able to understand how to read financial reports.
Foolish Assumptions
To write this book, I made some basic assumptions about who you are. I assume that you
Want to know more about the information in financial reports and how you can use it.Want to know the basics of financial reporting.Need to gather some analytical tools to more effectively use financial reports for your own investing or career goals.Need a better understanding of the financial reports you receive from the company you work for to analyze the results of your department or division.Want to get a better handle on what goes into financial reports, how they're developed, and how to use the information to measure the financial success of your own company.Both investors and company insiders who aren't familiar with the ins and outs of financial reports can benefit from the information and tools I include in this book.
Icons Used in This Book
Throughout the book, I use icons to flag parts of the text that you'll want to notice. Here's a list of the icons and what they mean.
This icon points out ideas for improving your financial report reading skills and directs you to some useful financial resources.
This icon highlights information you definitely want to remember.
This icon points out a critical piece of information that can help you find the dangers and perils in financial reports. I also use this icon to emphasize information you definitely don't want to skip or skim when reading a financial report.
This icon highlights information that may explain the numbers in more detail than you care to know. Don't worry; you can skip these points without missing the big picture!
Throughout the book, I give examples from financial reports of real companies, particularly Mattel and Hasbro. I highlight these examples with the icon you see here.
Beyond the Book
In addition to the material in the print or e-book you're reading right now, this product comes with some access-anywhere goodies on the web. You'll probably need reminders about the key parts of an annual report or the best financial analysis formulas to use. Check out the Cheat Sheet at www.dummies.com/cheatsheet/readingfinancialreports. You can find other useful information related to reading financial reports at www.dummies.com/extras/readingfinancialreports.
Where to Go from Here
You can start reading anywhere in this book, but if you're totally new to financial reports, you definitely want to start with Part I so you can get a good handle on the basics before delving into the financial information. If you already know the basics, turn to Part II to begin dissecting the parts of a financial report. And to get started on the road to analyzing the numbers, turn to Part III. If your priority is tools for optimizing company operation, you may want to begin with Part IV. Turn right to Part V if you want to know more about company outsiders involved in the financial reporting process.
Part I
Getting Started with Reading Financial Reports
Visit www.dummies.com for free access to great Dummies content online.
In this part…
Explore the types of financial reports and get to know the key financial statements.Discover business types and their tax rules, including sole proprietorships, partnerships, and limited liability companies.Differentiate between public and private companies, and understand what it means when a company decides to go public.Understand accounting basics – enough to understand different kinds of profit, and to distinguish debits from credits.Chapter 2
Recognizing Business Types and Their Tax Rules
In This Chapter
Exploring sole proprietorships
Taking a look at partnerships
Checking out limited liability companies
Comparing different types of corporations
All businesses need to prepare key financial statements, but some businesses can prepare less formal statements than others. The way a business is legally organized greatly impacts the way it reports its financials to the public and the depth of that reporting.
For a small business, financial reporting is needed only to monitor the success or failure of operations. But as the business grows, and as more outsiders — such as investors and creditors — become involved, financial reporting becomes more formalized until the company reaches the point at which audited financial statements are required.
Each business structure also follows a different set of rules about what financial information the business must file with state, local, and federal agencies. In this chapter, I review the basics on how each type of business structure is organized, how taxation differs, which forms the business must file, and what types of financial reports are required.
Flying Solo: Sole Proprietorships
The simplest business structure is the sole proprietorship — the IRS's automatic classification for any business that an individual starts. Most new businesses with only one owner start out as sole proprietorships. Some never grow into anything larger. Others start adding partners and staff and may realize that incorporating is a wise decision for legal purposes. (Check out “Seeking Protection with Limited Liability Companies” and “Shielding Your Assets: S and C Corporations,” later in the chapter, to find out more about incorporating.)
To start a business as a sole proprietor, you don't have to do anything official, like file government papers or register with the IRS. In fact, unless you formally incorporate — follow a process that makes the business a separate legal entity — the IRS considers the business a sole proprietorship. (I talk more about incorporation and the process of forming corporations in the upcoming section titled “Shielding Your Assets: S and C Corporations.”)
The fact that the business isn't a separate legal entity is the biggest risk of a sole proprietorship. All debts or claims against the business are filed against the sole proprietor's personal property. If a sole proprietor is sued, insurance is the only form of protection against losing everything.
Keeping taxes personal
Sole proprietorships aren't taxable entities, and sole proprietors don't have to fill out separate tax forms for their businesses. The only financial reporting sole proprietors must do is add a few forms about their business entity to their personal tax returns.
Most sole proprietors add Schedule C — a “Profit or Loss from Business” form — to their personal tax returns, but some choose an even simpler form, called Schedule C-EZ, “Net Profit from Business.” In addition, a sole proprietor must pay both the employer and employee sides of Social Security and Medicare taxes using Schedule SE, “Self-Employment Tax.” These taxes total 15.3 percent of net business income, or the business income after all business expenses have been subtracted.
Sole proprietors in specialized businesses may have different IRS forms to fill out. Farmers use Schedule F, “Profit or Loss from Farming.” People who own rental real estate but don't operate a real estate business use Schedule E, “Supplemental Income and Loss.”
Reviewing requirements for reporting
Financial reporting requirements don't exist for sole proprietors unless they seek funding from outside sources, such as a bank loan or a loan from the U.S. Small Business Administration. When a business seeks outside funding, the funding source likely provides guidelines for how the business should present financial information.
When sole proprietors apply for a business loan, they fill out a form that shows their assets and liabilities. In addition, they're usually required to provide a basic profit and loss statement. Depending on the size of the loan, they may even have to submit a formal business plan stating their goals, objectives, and implementation plans.
Even though financial reports aren't required for a sole proprietorship that isn't seeking outside funding, it makes good business sense to complete periodic profit and loss statements to keep tabs on how well the business is doing and to find any problems before they become too huge to fix. These reports don't have to adhere to formal generally accepted accounting principles (GAAP; see Chapter 18), but honesty is the best policy. You're fooling only yourself if you decide to make your financial condition look better on paper than it really is.
Joining Forces: Partnerships
The IRS automatically considers any business started by more than one person a partnership. Each person in the partnership is equally liable for the activities of the business, but because more than one person is involved, a partnership is a slightly more complicated company type than a sole proprietorship. Partners have to sort out the following legal issues:
How they divide profitsHow they can sell the businessWhat happens if one partner becomes sick or diesHow they dissolve the partnership if one of the partners wants outBecause of the number of options, a partnership is the most flexible business structure for a business that involves more than one person. But to avoid future problems that can destroy an otherwise successful business, partners should decide on all these issues before opening their business's doors.
Partnering up on taxes
Partnerships aren't taxable entities, but partners do have to file a “U.S. Return of Partnership Income” using IRS Form 1065. This form, which shows income, deductions, and other tax-related business data, is for information purposes only. It lists each partner's share of taxable income, called a Schedule K-1, “Partner's Share of Income, Credits, Deductions, Etc.” Each individual partner must report that income on his or her personal tax return.
Meeting reporting requirements
Unless a partnership seeks outside funding, its financial reports don't have to be presented in any special way because the reports don't have to satisfy anyone but the partners. Partnerships do need reports to monitor the success or failure of business operations, but they don't have to be completed to meet GAAP standards (see Chapter 18). Usually, when more than one person is involved, the partners decide among themselves what type of financial reporting is required and who's responsible for preparing those reports.
If the partnership seeks funding from a bank or investors, more formal reporting may be needed, such as audited financial statements and business plans.
Seeking Protection with Limited Liability Companies
A partnership or sole proprietorship can limit its liability by using an entity called a limited liability company, or LLC. First established in the U.S. about 30 years ago, LLCs didn't become popular until the mid-1990s, when most states approved them.
This business form actually falls somewhere between a corporation and a partnership or sole proprietorship in terms of protection by the law. Because LLCs are state entities, any legal protections offered to the owners of an LLC are dependent on the laws of the state where it's established. In most states, LLC owners get the same legal protection from lawsuits as the federal law provides to corporations, but unlike the federal laws, these protections haven't been tested fully in the state courts.
Reporting requirements for LLCs aren't as strict as they are for a corporation, but many partnerships do decide to have their books audited to satisfy all the partners that the financial information is being kept accurately and within internal control procedures determined by the partners.
Taking stock of taxes
LLCs let sole proprietorships and partnerships have their cake and eat it, too: They get the same legal protection from liability as a corporation but don't have to pay corporate taxes or file all the forms required of a corporation. In fact, the IRS treats LLCs as partnerships or sole proprietorships unless they ask to be taxed as corporations by using Form 8832, “Entity Classification Election.”
