If you are in business, regardless of the business entity you choose (e.g. Sole Proprietor, (Pty) Ltd Company or Close Corporation) you need to prepare Annual Financial Statements. This is because the Companies Act and the tax man, also known as The South African Revenue Services (SARS), says so!
It should be obvious in any event that the only way to really know what is going on in your business is by keeping complete and accurate books and records of your trading transactions. It is best practice to prepare financial statements, also known as management accounts, on a monthly basis so that you can use them to make ongoing and sound business decisions. Annually however, you MUST prepare, or have an accountant help you prepare, a set of Annual Financial Statements.
The preparation of Annual Financial Statements for a (Pty) Ltd is governed by the new Companies Act No. 71 of 2008, which came into effect on 1 May 2011.
But not all Financial Statements are equal!
Depending on the business entity that you trade in, the level of detail required to be included in your Annual Financial Statements will vary greatly.
In terms of the Act, there are 3 possible processes that have to happen in order to prepare the Financial Statements. They are:
A statutory audit
An Independent Review
From a cost perspective, a statutory audit costs by far the most, followed by an independent review and then a compilation.
Without trying to dazzle you with accounting mumbo jumbo, an auditor expresses an opinion on the Annual Financial Statement at the end of the audit. The goal is to express an unqualified opinion as to whether the Annual Financial Statement fairly present the financial position of the Company.
The auditor is trying to ensure that there is no “Material Misstatement” in the Annual Financial Statement and in order to do this, he will have to perform an involved set of audit procedures that are designed to detect such material misstatements.
The best way to try and explain this is by way of example:
Let us say that your bookkeeper prepares your Annual Financial Statement and it shows a net profit after tax of say R5 million, which you present to a bank because you have asked for a R1 million overdraft. The bank then grants this overdraft based on your Annual Financial Statements.
Now let’s assume that you made a few errors and that the actual net profit after tax is only R4,8 million and not R5 million…
Would the bank now make a different decision? Would they still give you the R1 million overdraft once they discover this R200k error? In most cases, the answer would probably be yes.
Let’s now assume that the actual net profit after tax was only R2 million because we now discovered a R3 million error…would the bank grant the R1 million overdraft now? Probably not. This is because the size of the error was big enough to result in them making a different decision.
In essence the error resulted in a material misstatement of your Annual Financial Statements