Tax Tip of the Week | October 13, 2010 | No. 62
Financial Statements – How They Can Help
Analyzing Your Financial Statements
You are working hard, very hard. In fact, you have never worked so hard in your life. Your employees are also working hard. Therefore, your business must be doing, amazingly well. Right? BUT…your bank account is nearly empty, your desk drawer is full of checks that you can’t mail, and your line of credit is maxed. So, what is wrong – where is all the cash going? Often, the mystery may be explained by analyzing your financial statements.
You will want to use at least the following reports:
(1) The Balance Sheet – this is a record of your business’s assets, liabilities, and equity as of a certain moment in time or a snapshot.
(2) The Profit and Loss Statement or aka the Income Statement – this is a recap of your business’s sales, expenses, and net profit (or loss) over a specific period of time.
(3) The Cash Flow Statement – this will show a recap of the actual increases and decreases of cash coming into and out of your checking account.
Use your financial statements to compute your ratios or metrics. Learn which ratios are typically used by your industry. Compare your results to these ratios. Some of these ratios may include – aging of accounts receivable and accounts payable, inventory turnover, gross profit margins and a percentage of net income to sales – just to name a few. All of these and more will help you provide a scorecard on the health of your business and explain what is going on behind the scenes. For example, is your cash funding higher accounts receivables and higher inventory levels because of double digit growth in your sales? Or, is your cash funding an operating loss because your sales are not high enough to cover your overhead? Your financial statements will also show you why your checkbook balance has little value in determining your profits.
In addition to using monthly financial statements many companies will also use the underlying data for them to create daily or weekly flash reports. One rule for flash reports is they should not exceed one page – keep them short. They typically include the information necessary to drive the business forward to meet your strategic plan. For example, they may show the sales or parts produced for the preceding day as compared to a predetermined target in an effort to change direction and methodology as needed on a very short notice.
Side note: Timely (within 10 days following month end) and accurate financial statements that use the accrual method of accounting (i.e. where accounts receivable, inventory, accounts payable and various accrued liabilities are recorded) is crucial. One cannot expect to make great decisions from poor information or information that is outdated. And, don’t forget the IRS expects accurate reporting as well.
This week’s author: Mark Bradstreet, CPA
Rick Prewitt – the guy behind TTW
…until next week.