How Can Investors Check That a Portfolio Company's Financial Statements Are Reliable?

Reliable portfolio company statements let you trace reported figures back to the records behind them. Start by learning who prepared the accounts, what review took place, and whether the company can provide supporting evidence without unexplained gaps.

Establish the Reporting Process

Request financial statements for each period under review, the accounting policies, and any audit or review report. Ask whether the statements use a consistent accounting basis and whether policies or reporting periods changed. If there are subsidiaries, request the entity chart and consolidation schedules. Also ask for reconciliations of intercompany balances.

Find out who enters transactions and approves journal entries. Ask who reconciles accounts and prepares reports. Request a sample close calendar, along with the list of accounts reconciled each period. If one person controls cash, records transactions, and prepares the statements, errors may go undetected. Ask what review takes place and who signs off on adjustments.

Trace Key Figures to Source Records

Choose significant revenue and expense accounts, then follow amounts from the ledger to invoices, contracts, payment records, and bank activity. For revenue, compare billed amounts with customer agreements and receipts. For major expenses, inspect vendor invoices and payment records. Ask how management distinguishes operating costs from items recorded as assets. Request schedules supporting receivables, inventory, and payables. Include capital spending schedules.

Reconcile cash balances to bank statements. Match debt to lender statements and executed agreements. Ask for bank reconciliations and investigate stale outstanding items, unexplained transfers, or balances that do not match the statements. Compare earnings with operating cash flow. A widening gap can come from slow collections, inventory build, unpaid bills, or accounting estimates. Ask for a bridge explaining the movement.

Test Estimates and Unusual Changes

Request details behind material estimates, including reserves for doubtful receivables, inventory write-downs, warranty costs, and accrued expenses where relevant. Compare estimates with later collections, write-offs, claims, or payments. Review journal entries made near period end, especially large manual entries, reversals in the next period, or entries posted by senior staff.

Compare results across periods with operating records such as units sold, production, occupancy, or customer activity where they fit the business. Ask management to explain material changes and provide the calculation and supporting record. Review related-party vendor and employee transactions in the ledger. Then compare charges with contracts and invoices. A late explanation or missing source record calls for investigation; by itself, it does not prove misconduct.

Ask for Answers You Can Test

Ask direct questions and request a supporting document for each answer:

• "Who prepared these statements, and who reviewed the close?"
• "Which accounting policies changed, and where is the effect reconciled?"
• "Can we trace this revenue balance to contracts, invoices, and the ledger? Where do collections appear?"
• "What explains the difference between net income and cash from operations?"
• "Which estimates or journal entries had the largest effect on reported earnings?"

Request general ledger exports and trial balances. Gather bank and lender statements, reconciliations, tax returns, audit reports, management letters, and schedules for significant estimates. An independent accountant can test the records and explain accounting issues. For the investment context, see what to inspect before buying a private company stake. Talk with your CPA about tax and accounting specifics.

Checklist

• Confirm the accounting basis and reporting history.
• Identify who prepares the books and approves entries. Find out who reconciles them.
• Trace material revenue and expenses to source documents.
• Reconcile cash and debt to third-party records.
• Test estimates and period-end entries. Review related-party charges.
• Record unresolved differences and the evidence still needed.

Go deeper: What should an investor examine in a fund's audited financial statements?; How can investors check that a fund's assets and valuations are real?; What records should support a manager's claimed investment results?.

I wouldn't trust the statements unless I had my own auditor doing something and double checking.

Sources: Family Office Club investor due diligence framework, The Family Office Book. Informational only, not financial, legal or tax advice.