Written by Stephen Beard, Managing Director of Plyo Bookkeeping, a Vancouver-based bookkeeping firm.

When you ask your accountant or bookkeeper for financial reports such as a Profit & Loss (P&L) or Balance Sheet, you’ll likely hear them add the disclaimer, ‘unadjusted’ to the financial reports they give you – but what does this mean?

There are really two types of financial reports, unadjusted and adjusted. Unadjusted just means that the raw financial information as entered in your accounting system is turned into a report, without any adjustments or alterations at the end. Unsurprisingly, adjusted means that journals were posted so that the report represents the financial data in a way that better represents reality – and which usually helps one make more informed decisions.

When do I need adjusted reports?

Not all businesses need adjusted financial reports on a monthly basis to be able to make sound strategy decisions, as frequently unadjusted reports are adequate for this purpose. So when might your business need adjusted financial reports? Below are some common situations:

Deferred revenue

Perhaps you own a gym and the majority of your memberships are paid for annually. You get 50% of your signups for the entire year in January, due to everyone taking their New Years resolution to get fitter. In an unadjusted P&L, your January will look spectacular, but your June will likely look like it’s running at a loss. You have the costs of running your gym every single month, so really some of the annual membership money paid upfront needs to be assigned to each month of the year. In this case your bookkeeper would need to create an adjustment to reapportion this income evenly over the year.

Cost of Good Sold

Inventory tracking can be complex, and most smaller businesses do not have a financial system that automatically calculated COGS when sales are made. When you purchase inventory, it’s categorized as an asset that you own, and doesn’t hit the P&L. If you own a shoe shop, you’re unadjusted P&L will be overstated unless an inventory adjustment is made each month to reflect the amount of inventory which was sold during the month. Similar to deferred revenue, it stems from an accounting principle that means that related sales and costs should be recognized in the same period.

Timing Adjustments

There are many situations where bills for major costs that relate to a period arrive after the period they relate to. Perhaps you completed a small renovation job and your subcontractor sent you a bill that falls in the month after you invoiced for the renovation. An accrual for the subcontractor cost would need to be created to again match the costs with the related revenue in the financial reports. Similar to this scenario, companies that pay employees every two weeks can sometimes find that three payrolls end up in a single month. If wages are a major cost this can distort the P&L and make a given month look less profitable than it really was. This could again be adjusted so as to improve the accuracy of the financial reports.

When are unadjusted reports adequate?

Unadjusted reports are frequently adequate for many small business owners. Service businesses with payroll on a semi-monthly or monthly basis are unlikely to require many major adjustments, so the unadjusted reports will be accurate enough for making sensible business decisions.

As a rule of thumb, if your business deals with inventory, receives sales income upfront for substantial services not yet delivered, or deals with large one-off projects where there are a lot of associated costs – adjusted reports will be essential.  

Year End Financials

Every year your accountant will prepare financial reports as part of your T2 corporate income tax return. These are always fully adjusted. Your accountant will prepare a list of year end adjustments which you need to make sure get posted into your financial system.

Partially Adjusted vs Full Adjusted

Earlier I said there were just two types of financial report, unadjusted and adjusted. This was an oversimplification. While your year end accounts will always be fully adjusted, monthly financial reports will often only make the essential, major adjustments. These partially adjusted reports will provide information that is accurate enough to make the right business decisions, but they avoid the full list of adjustments performed at year end.  

Conclusion

You first need to understand the nature of your business, and you can then decide whether unadjusted reports already represent an accurate view of your business. If they don’t, you should chat with you accountant or bookkeeper and determine what adjustments are key to creating financial reports that give you the required level of accuracy for running your business.