Family businesses may not always need to issue formal financial statements. Absent the need to report to others, you can probably get by with simple flash reports and cash flow projections. But if your family business’s associates include outside shareholders and lenders, you may need to generate complex financial statements with footnotes and detailed disclosure remarks.

When financial statements are necessary, you must have them prepared in accordance with generally accepted accounting principals. However, you may choose among several levels of complexity, detail and verification. Let’s look at the basics of choosing the most suitable financial statement level for your company.

Pick Your Position
First, determine your audience and its needs as well as your company’s needs, including cost considerations. Pick a financial statement level that matches your company’s size and your audience’s demands. Ordinarily, larger family businesses need higher-level financial statements – lenders and other financial statement readers may not accept lower-level financial statements from big companies. And smaller family businesses may find higher-level financial statements costly and unnecessary.

The 3 Financial Statement Levels
Generally, the accounting profession sanctions three financial statement levels:

1. Compilation. The easiest and least costly financial statement, a compilation presents your company’s financial information in a relatively uniform and readable format. Generally, accountants generating compilation statements will not verify your company’s financial information. Your accountant merely presents the information you provide in an acceptable format. (Accountants are not responsible for incorrect financial information unless they know it is incorrect.) Most compilations do not include footnotes, but some accountants will prepare them, at least in limited fashion.

Some compilations use the cash method (often referred to as “tax basis”), instead of the usual accrual method. If your accountant agrees to do this, he or she will disclose it in an accountant’s opinion letter accompanying your financial statement. The most common problem with a compiled statement is lack of verification -- it may fail to satisfy your audience’s needs, especially if your company is large or especially lucrative.

2. Review. A reviewed statement is more complex and generated using the accrual accounting method. Unlike a compilation, your accountant will verify your account balances and provide a full set of footnotes. But your accountant will verify this information only internally. He or she will not contact outside parties dealing with your family business to authenticate your accounts. A reviewed statement also includes a full inventory verification, accounts receivable and payables tests, and fixed-asset observation.

Generally, this level is best for mid-sized family businesses that work with a significant but limited number of outside parties. If you maintain good relationships with your outside business associates, a review will probably satisfy their needs. But if you need to prove your financial information’s soundness, or you expect to expand or sell your family business in the near future, this financial statement may not suit your needs.

3. Audit. An audit is the most comprehensive and costly financial statement level. Your accountant will verify your finances internally and contact outside parties to determine how much you owe them or how much they owe you. He or she will also examine sample invoices, count inventories, and search for potential or contingent liabilities. Such intricacies are especially important if your family business is a public company, if you intend to apply for a grant with certain government and tax-exempt agencies, or if investors or lenders require an audit. Your accountant will most likely use the accrual method of accounting to present your statement and will provide a full set of footnotes. Remember, an audited statement does not necessarily detect fraud, though it may uncover suspicious accounting problems.

Know Your Needs
Typically, tension exists between the financial statement level a family business wants to present and the level that company’s audience wants to read. And because your financial statement presents historical information, you may find its usefulness limited.
So which level is right for you? Remember, the higher the statement level, the more it will cost. But ultimately, the answer depends on your family business and its outside reporting needs.

The Flexibility of Reviewed Statements
Many outside business entities consider your financial statement a sort of insurance policy. They want reassurance that your business is in good shape and they want to use your financial statement as proof. For instance, banks, potential buyers and investors want audited statements to ensure that your family business is financially strong and meeting your loan covenants. In fact, for many years, audited statements were the standard. But many family business owners complained about the excessive cost, especially because the information recorded on the financial statements was old and of little use to their companies. Fortunately, accountants responded with the reviewed statement, which has since gained wide acceptance.

Your accountant can usually convert a reviewed statement to an audited statement -- but only if he or she performs certain audit techniques while preparing the reviewed statement. Doing so cuts your costs but maintains flexibility in case you need an audited statement in the near future. Generally, the business community has accepted reviewed statements. If you notify the people who read your financial statement, you can probably convince them to accept one. And if you’re considering selling your family business -- or going public -- a reviewed statement’s “convertability” is a real plus.