Small-business owners often wear many hats. One of those hats is that of the CFO. This leaves the owner with the unenviable task of reading and interpreting the company’s financial statements. Tackling financial statements can be a daunting task for the untrained, spread-too-thin, non-accountant, business owner, however, interpreting these documents is a critical part of wearing the strategic planning hat, also donned by today’s best business owners. Interpreting your financial statements can be a simpler task than most owners think, and really begins with ensuring you’re asking the right questions.
The financial statements that a small-business owner reviews are like a historical scorecard that will answer the question, “How did the business perform last month?” As a business owner, though, the most important question for you to answer first is, “What are these monthly financial statements really telling me?”
To begin answering this question, you first should be reviewing your balance sheet and income statement on a monthly basis. Your monthly balance sheet will tell you that you have some cash, some accounts receivable, some inventory, some accounts payable, some debt, and some owner’s equity. On the other hand, your monthly income statement will tell you that you have sales, cost of goods sold, selling, general, and administrative expenses, net income, and net loss. Now what?
Now that we’ve defined the basic content of your income statement and balance sheet, it’s most helpful to review your financial statements compared to the prior month, the same month last year, or to your budget so that you can begin asking—and answering—the question, “How did my business perform relative to the prior period or to the budget.” This simple comparative analysis will help you formulate your future plans and make timely changes to your plans and processes.
In order to draw deeper insights about your business’s performance, it’s helpful to perform a ratio analysis, comparing the business, again, to prior periods, budgeted expectations, and if available, industry expectations. Business owners use this kind of analysis to help them make data-driven decisions about possible changes in future plans and processes.
For example, businesses with significant levels of inventory should be monitoring the day’s inventory on-hand on a regular basis. When the ratio of the day’s inventory on-hand starts to rise, the business owner could conclude that excessive inventory levels exist and decide that purchasing should be curtailed. Of course, detailed analysis of the resulting ratio should be performed in order to determine the best course of action to be taken.
Another common and important area for business owners to monitor is gross margin or gross profit. Keeping a close tab on the gross margin as a percent of sales will help the business owner make decisions about future pricing and direct costs, such as labor and materials required to produce a product or service. If margins are being reduced, the business owner may need to evaluate the pricing strategy or change the inputs that go into producing the good or service so that margins can be maintained at the level necessary to produce a profit.
Reviewing and analyzing the numbers on your monthly balance sheet and income statement is a critical task that should be performed each month. As the business owner, the results of your analysis will yield timely information for you, helping you react and make changes to your operations and processes. If you are not getting information from your financial statements that provides you with actionable items, call the business accounting experts at Burke & Schindler. Our professionals are trained to analyze financial statements and provide business owners with the constructive feedback to improve business operations and processes day after day.