If you want a clear understanding of how your business is doing financially, and you want to be able to predict and plan for the future, a fairly thorough understanding of your financial statements is essential. A sound understanding of financial statements will help you:
- Identify unfavorable trends and tendencies in your business’s operations (for example, the unhealthy build up of inventory or accounts receivable) before the situation becomes critical.
- Monitor your cash flow requirements on a timely basis, and identify financing needs early.
- Monitor important indicators of financial health (for example, liquidity ratios, efficiency ratios, profitability ratios and solvency ratios).
- Monitor periodic increases and decreases in wealth (specifically, owner’s or stockholders’ equity)
- Monitor your performance against your financial plan, if you have developed one. If you have not – you need to get on that quickly.
Keep in mind that your financial statements are only a starting point for analysis. Individual numbers aren’t good or bad in themselves – you may have to dig for the reason behind any numbers that seem out of whack. For instance, if your statements shows that your accounts receivable have trended significantly downward over the last few years, it could mean that you are not collecting the accounts more aggressively (which is good), or it could mean that you are writing off accounts as uncollectible too soon (which is bad). If your accounts payable or your notes payable sections keep growing rather than decreasing over a period of time, then the income portion of the statement needs to be checked. Something is really out of whack here. The key is to use your statements to spot trends and anomalies, and then follow these up with further investigation.
The creation of your financial statements is largely a mechanical exercise. The numbers to be used are found in your accounting records after the books are closed at the end of the period; to draw up the statements you, or your accountant, or your accounting software simply look up the numbers and plug them into the statement blanks. Using the numbers to your benefit is a real asset. The real value to the statements come after their creation, when you analyze them to see how your business is doing in numerous areas. You don’t have to know the exact makeup of each item on the balance sheet and income statement, but you must have a sense of what the numbers mean in order to interpret and analyze these financial records. Raw data in isolation does not make sense – it’s relationship to the rest of the financial information that counts and makes it become effective. The following checklist may help make sense of the financial data.
This is a checklist of issues you may want to consider after your financial statements are prepared.
- Develop common size financial statements to compare – Present performance with past performance and the condition of your business with that of other similar business operations.
- Develop the key business ratios for the business to compare – Present performance with past performance and the condition of your business with that of other similar operations. Consider the impact on the performance picture of inflation and different accounting practices and procedures.
- Project income and construct a cash flow budget to assess production requirements and financing needs. Achieve a fair return on investment (capital) at a level of risk acceptable to you. Maintain working capital at sufficient levels to support operations. Maintain a proper balance between current assets and fixed assets.
- Establish and maintain a proper level of capitalization with the best mix of short-term and long-term debt financing and equity financing.
- Examine your fixed and variable costs and relate them to profits.
- Evaluate and project how markets, products, competition and sales affect and will affect your profits.
- Establish a breakeven point for the operation as a first step in determining how changes in sales will affect costs and profits.
- Review the degree of operating leverage in the operation and its effects on operating profit and return on equity.
- Consider how growth in sales and profits usually increases the need for additional financing.
There are four basic statements that we are going to focus during our online class. They are as follows:
- Statement of Cash Flows
- Income Statement
- Statement of Owner’s Equity
A list of the assets, liabilities and owner’s equity of a business entity as a specific date, usually at the close of the last day of a month or of a year.
STATEMENT OF CASH FLOWS
A summary of the cash receipts and cash payments of a business entity for a specific period of time, such as a month or a year.
A summary of the revenue and the expenses of a business entity for a specific period of time, such as a month or a year.
STATEMENT OF OWNER’S EQUITY
A summary of the changes in the owner’s equity of a business entity that have occurred during a specific period of time, such as a month or a year.