WANTED: Financial Statement Interpreter
July 30, 2019
by Aundrea Wilcox | Executive Director, KOSBE
This weekend, I was scouring the Internet looking for ideas that small business owners can use to improve their bottom line, when I came across an article on palm reading. You might be asking ... “What does this have to do with business?” Well, I found myself attempting to read my own palm just for fun, but I quickly doubted and dismissed what it told me. In other words, my reading was skewed to what I wanted to hear. For example, my life line seemed too short, so I immediately disregarded that because who wants to die at such a young age? I didn’t see a success line at all which is not unusual—so it said, but still I disregarded that because I strive for success every day, and I’ll be darned if I don’t get someplace good eventually—I’ve worked too hard to settle for anything less, right?!
In the real world, it’s crucial for small business owners to be able to “read” their financial statements before making any major financial decisions such as borrowing money, signing a long-term lease or agreement, buying a building, etc. Financial analysis is a deep evaluation of financial events and interpretation by an experienced and knowledgeable professional, like a banker, attorney, CPA or business consultant.
You need copies of the past two or three years of your Balance Sheet and Income Statement as a minimum to perform a comprehensive analysis that measures your liquidity, profitability, sales, borrowing, and asset utilization.
LIQUIDITY is a measure of your ability to meet financial obligations. If sales and profits have increased significantly but liquidity has stayed flat, you need to make some changes. An analysis of your financial statements will show whether or not you have invested enough resources in cash accounts, and if you have a sufficient amount of total current assets as compared to short-term liabilities. To increase cash flow, you might consider renting rather than buying in some instances. Also make sure you are sending out invoices in a timely manner and without needless clerical errors that can slow down the payment process. Are you using cash for activities that are unrelated to the business, e.g., personal loans? Are you able to accept credit cards? Why wait 30 days when you can get paid immediately?
PROFIT MARGIN shows whether the trends in profit are positive or negative for the company. If net profit margin and gross profit margin have both fallen from the last period, this might indicate that the company is not controlling the expense side of the business as it should be. Consequently, you will want to nip this before things get even more out of hand. Compare your profit margin to other businesses in your industry and try to do better than the standard.
SALES should help improve profitability if they are growing and expenses are managed efficiently. Be sure to develop relationships with your clients, other service providers and vendors to help gain referrals for new business.
BORROWING activities can help profitability also, but be careful of the cost and risk associated with it. Are you already having a hard time fulfilling any current debts? If you can grow your business without adding debt, it might be the most prudent competitive move you can make.
ASSETS measure how effectively you are utilizing your gross fixed assets. This is especially insightful for businesses that use heavy machinery or equipment to manufacture a product.
At the end of the day, you can’t leave your financial statement analysis to just anyone to perform—as you can see you could be in danger of drawing the wrong conclusions, leading to a series of additional bad choices. A bunch of numbers at the end of a financial period doesn’t mean anything—you have to pick up on the story behind the numbers. Conducting an analysis on a regular basis can assist you in business development, and help you prepare for the future. Make sure you are working with a financial planner, banker, CPA or consultant you can trust who will be your interpreter or storyteller over the long run. Yes, consistency does matter. And make sure that you are at least familiar with the basics of financial statement analysis yourself.
You can get free access to online training for small businesses at www.sba.gov, or visit a local small business development center for in-person one-on-one assistance or to inquire about group training opportunities.