WHAT ARE ANNUAL FINANCIAL STATEMENTS? LET’S TALK AFS
Annual Financial Statements (AFS) are in a nutshell a story book of the business, this is how a company communicates to the world about its financial performance, financial strength and liquidity status.
SARS requires that you file annual tax returns and they require all companies with the exception of dormant ones, body corporates and microbusinesses (below R1 million turnover) to submit “signed financial statements”. There is no definition for this, so if you have basic accounting knowledge you can prepare your own Income Statement and Balance Sheet, sign it and submit to SARS. You don’t need AFS that have been prepared by a professional accountant.
This approach is definitely not recommended though, because AFS serve more than just a tax compliance requirement. They come as a standard compliance requirement when applying for funding or when looking to do business with the government. These stakeholders are not likely to consider informal AFS.
Classification of Annual Financial Statements
There are different types of AFS and this where most business owners get confused and end up unsure what AFS they have authorised. Accountants have a habit of not explaining this very well to entrepreneurs as well and they end up paying for what they do not need.
What differentiates a set of AFS from another is the person who has signed of your AFS. This could be yourself or an accountant who works in the business, your accountant who does your monthly accounting, an accountant who is not involved in your monthly accounting or an external auditor.
Signatures from these different people give what we call a level of assurance. The more isolated they are from your business, the higher the level of assurance.
AFS can either be:
- Compilation AFS – prepared internally or externally by a professional. This could be an outsourced accountant that prepares your monthly management accounts as well. These AFS provide a Basic level of assurance.
- Independently Reviewed AFS – signed off by an Independent Reviewer who was not involved in the daily financial management of the company. These AFS provide a Limited level of assurance.
- Audited AFS – signed off by independent external auditors. These AFS provide a Highest level of assurance.
Let’s summarise this below:
Internal Accountant will be your inhouse accountant who is involved in your daily financial management. If they are adequately skilled, they should be able to compile AFS based on the monthly management account they have been keeping.
External Accountants will be your outsourced accountants which could be appointed specifically for the AFS’s function or they could be assisting the business with financial management on a monthly basis. Depending on your arrangement, the cost of these AFS would normally be included in your monthly retainer.
An Independent Reviewer is an accounting professional who is independent to the financial management of the company. Their work will include a review of the company’s financial records and then express an opinion on the AFS. This person can therefore not be the accountant that perform your monthly accounting. What usually happens in practice is that your monthly accountant (internal or external) will compile the AFS then submit them to an external accounting practitioner who will then perform an independent review and sign-off the AFS. This process is less onerous than audit, therefore it’s quicker and cheaper.
An Auditor is an independent external professional who performs a detailed examination of a company’s financial records and expresses an audit opinion on the accuracy of the AFS. The audit process is much more onerous and more expensive. Its rarely required for a small business to have audited AFS.
So how do you know which AFS to prepare for your business?
You will know the kind of AFS to prepare by knowing something called a PI Score Public Interest Score (PI Score). This score will tell you the level of assurance required for the size of your business, which 90% of the time will either be a Compilation for small businesses. Its important to use this score as your guide to avoid incurring unnecessary costs.
It’s also worth noting that most funders prefer Independently Reviewed or Audited AFS so if you intend to use your AFS for raising funds, rather have them Independently Reviewed at least.
Professional accountants do charge differently for the different types of AFS because as you can correctly guess, the higher the level of assurance required on the AFS, the more work performed.
Having your AFS being prepared by a professional accountant is worth the investment. Not only does it add credibility, but you are telling the world a story about your company and any author knows that to have a successful book, you need a good publisher.
