How Can a Family Office Uncover Liabilities That Are Missing From a Company's Accounts?

Compare the company's accounts with records of its obligations. A balance sheet may omit a payment, guarantee, claim, or commitment documented in a contract, bank transaction, tax record, or legal file.

Reconcile Balances to Source Documents

Request the general ledger, trial balance, monthly financial statements, bank statements, tax filings, debt schedules, and accounts payable aging. Match material balances to invoices, loan statements, payroll records, and payment confirmations. Review payments made after the reporting date and ask whether each concerns an obligation incurred before that date. Seek support for large later payments, old unpaid invoices, or recurring manual entries.

Ask, "What obligations were incurred before the reporting date but paid afterward?" Also ask, "Which expenses were paid by an owner or affiliate?" Compare cash activity with recorded expenses. Look for vendor payments absent from the payable ledger or expenses recorded in another entity. Ask management for a written explanation and a source document for each gap.

Read Contracts for Commitments and Guarantees

Review leases, loan agreements, vendor contracts, purchase contracts, and employment arrangements. Check indemnities and guarantees separately. Read insurance policies as well. Identify minimum payments, renewal terms, termination charges, make-whole provisions, and obligations triggered by a change in ownership. Ask whether the company guaranteed debt or performance for an affiliate, customer, or supplier. Check whether assets were pledged and whether the debt schedule reflects each pledge.

Compare contracts with board approvals, related-party records, and actual payments. A commitment may be conditional, disputed, or contingent. Record what triggers it and who can enforce it. Ask, "What commitments are not listed on the balance sheet, and where are they disclosed?" Ask also, "Has any party asserted a claim that management believes is remote or immaterial?" Discuss legal and tax specifics with the company's attorney and CPA.

Review Tax, Claims, and Operating Records

Compare tax returns and payment records with tax expense, payroll withholding, and sales tax accounts. Request notices, payment plans, audit correspondence, and proof of remittance where appropriate. Review legal matter schedules, demand letters, settlement discussions, and correspondence about disputed invoices. Search relevant court records when a specific claim or party warrants an independent check. Distinguish allegations from findings, and ask counsel to assess open matters.

Look for expenses that seem too low for the reported level of activity. Compare payroll and insurance costs with operating records. Check equipment use and occupancy records, then review maintenance records. Ask whether costs were deferred, capitalized, or paid by a related entity. Check affiliate balances against written agreements and bank activity. Red flags include unexplained cash transfers, repeated late payments, missing contracts, or answers unsupported by records.

Quantify Unresolved Items

For each possible liability, record its source and amount or range if supportable. Note its timing and trigger. Record the evidence still needed. Seek confirmation from a counterparty or independent source for material items. Include credible obligations in a downside cash case and assess whether they could disrupt operations or change the investment terms. Keep uncertainty visible; a verbal assurance does not clear an unresolved item.

This page focuses on obligations missing from the accounts. For financial statement reliability, see how to check portfolio company financial statements. For the effect of debt terms on remedies and restrictions, see questions about company debt covenants.

Checklist

• Reconcile ledgers with bank activity, tax filings, and later payments.
• Review contracts for guarantees and renewal terms. Check penalties and commitments.
• Compare related-party balances with agreements and actual transfers.
• Check tax notices and claims. Review disputes and court records where relevant.
• Record each open item, its trigger and timing, and evidence needed.
• Reflect credible unresolved obligations in the downside case.

Go deeper: What should an investor examine in a fund's audited financial statements?.

Potential Liabilities - These must be examined in detail since some can come with an existing business that is being contributed into the new venture, or the investor can be held liable for some in the new venture (like unpaid taxes).

Sources: How to Start a Family Office, The Single Family Office. Informational only, not financial, legal or tax advice.