Analyzing Financial Statements

Analyzing financial statements is more of an art than a science. It’s one of the most common chances lawyers have to pretend to be accountants, which some of us love and some detest. (I’m closer to group one.)

First and foremost, the overall financial picture has to add up. This is advice I give clients almost daily: the income/expenses and assets/debts ratios should match. More income than expenses should result in assets and little or no consumer debt. More expenses than income usually goes with few or mortgaged assets and plenty of consumer debt.

In other words: a litigant claiming income of $10,000 and expenses of $30,000, but who has $5.00 in the bank and no debts, isn’t believable. I’ve seen many people look at financial statements of that kind and shrug: sure, they’re broke. Well — yes, but there’s a bigger story hiding there. Either they’re confused about their expenses, there’s unreported income (parental contributions? Cash work?), or they’ve neglected to list some meaningful debts.

Alternately, a litigant claiming income of $200,000, expenses of $100,000, and no meaningful assets? Either they’ve got a very skewed idea of their own spending, or you should start seriously poking around for undisclosed investments and accounts.

Of course, there’s always the possibility that the income/expenses situation is new, and the assets/debts reflect an older situation. But if something raises flags, it’s well worth following up on them!

Another variation on these mismatches is when the litigant attempts to make the overall numbers work, in a way that makes the statement obviously false. I’ve seen this most often as: reported income of $40,000 (or $30,000, or $50,000); mortgage on massive, expensive house of $3,000 per month (or $2,500, or $3,500); then groceries $20 per month, cell phone $10 per month, few or no other expenses listed. Often, this represents the attempt of a person with a high unreported income to make their income/expense numbers “work.” Since the mortgage is a documented number, they can’t lie about it easily; instead, they lie about other, more fungible expenses, and hope no one notices. Have fun examining their bank statements — it shouldn’t be hard to show that $20 on groceries isn’t so accurate.

Individual expenses can also be revealing in this way. If under the expenses section, $1000 per month is going to pay debts, but no debts are listed, that’s a flag.

Comparing past financial statements, when you’ve been provided with a few, can be a delicious exercise. Many people slip up between one and the next, if they weren’t telling the truth in the first place. It’s hard to keep lies straight, particularly over the course of a two- or three-year proceeding.

For cases of failure to pay support (or costs), FRO has examination of financial statements down to a science. Watch FRO counsel at court, and you quickly see their technique: find every non-obligatory expense they list, and point out that those monies could go to support. Vacations? Not while you’re in arrears, buddy. Alcohol and cigarettes? Not so much. Gifts? Start hand-making them.

Legally, they’re quite right, particularly when it comes to child support, and there’s something remarkably compelling about pointing out that the children are being fed and housed without any (or enough) help from the payor while the payor is reporting spending twice the support amount on booze, restaurant meals, and clothes.

Finally — for this post, at least, as there’s much more to be said on the subject — don’t neglect the tax returns. There’s so much in there — not just the reported income but the source, for instance: “How and why did this person get a T4 for $1?” and “The sole proprietorship grossed $600,000 but only netted $15,000?”

Better yet are the schedules. Here’s a particular favourite from a past version of the tax return forms. I was acting for FRO at the first appearance of a default hearing. The payor, who had experienced counsel, reported years of income of only $1,200 per year, but was not on social assistance. “How does he survive?” I asked counsel.

“You know, I think he couchsurfs. He’s basically homeless,” he told me, empathy in his voice.

“Ah, that would make sense,” I said. “Except that he’s applied for the housing credit, and he’s told CRA he pays $1,100 a month in rent. Here’s his landlord’s name and number.”

“I … need a minute with my client,” counsel said, and we shortly reached agreement about voluntary payments.

Financial statements are a treasure trove. Spend time with them, and they often reward it with new avenues for proving your client’s case. Spend more time drafting, and you can help prevent your client’s case from being easily disproven.

Molly Leonard