Can you image playing a football game and never knowing the score? Financial statements provide owners their financial score. To keep the business financially healthy it is important to review your financial statement once a month. The challenge is that many don’t know what to look for.
But before you look make sure the statements are reliable enough to use.
Some areas to look at:
Accuracy – Do you really have $10,000 in the bank? Do you have $50,000 due from your customers? Do you owe your vendors $20,000? Do the sales reported agree with your sales reports? The numbers are just samples. Before you make any judgements or decisions based on the statements verify that you can trust them.
Timing – to get a true picture it is important that income is reported when earned and expenses are recorded when you receive the services or goods. This may differ from the tax return that is filed. It is common to report financial statements on the cash basis, however if customers pay in 30 days and you wait to pay your vendors it is difficult to match income to expenses.
Once you confirm that the statements are reliable and you are aware of timing issues, they can be a useful tool in judging the financial results and in making business decisions.
When I look at the financial statements here are some areas that I focus on:
1. Evaluate the business’ ability to generate profits. Most people go directly to the bottom line to look at Net profit. However it is important to know how those results were generated. Using the Income Statement look for answers to the following questions – Where are the sales coming from? Where are the profits being generated? Is gross margin reasonable? Look at a sales report by customer to clarify your observations.
Is there enough gross profit to cover overhead? Are the sales and marketing investments achieving the desired results? Note percentages of income as well as dollars.
By looking at multiply months, quarters or years you can tell if the results are the financial reporting are consistent. One can determine how productive the current system is and if they are following a system.
2. Determine the adequacy and use of the businesses current resources that are available. This is found by looking at the Balance Sheet and the relationship between the results reported on the income statement. Define working capital by subtracting current liabilities from current assets. At a minimum it should be positive, however the higher the number the better. This may indicate that the business debt structure could be improved.
In general are there more assets than liabilities? The more assets that exceed liabilities the stronger the business is financially. If inventory is utilized how often do they sell it? (Cost of Goods Sold/Inventory value) How many days of sales do they have in Accounts Receivable? How long does it take to get paid? Common sense says the sooner the better.
Calculate and review financial ratios. Compare them with the past and with industry averages if available.
Ideally the financial statement information will confirm what you think is happening. If they don’t’ there are two possibilities – your statements aren’t reliable or you don’t have a clear picture of the financial results of your business. Either way the financial statements can help you refine your game plan so you can improve your score!
If you need assistance in interpreting your statements, please contact our office. We can perform a financial analysis and meet to discuss our observations.