Working in the business financial consulting industry has taught me a lot of things, but one of the most important is that many small businesses struggle to successfully manage their financial statements. You might find this surprising since financial statements form the backbone of any business, but it’s true.
Financial statements outline the health of your business’s finances. If you don’t know how to read these correctly, you can get lost in the jungle and struggle to navigate the wild world of business ownership.
But don’t worry. I’ve provided professional financial consulting services for many years now, so I can help you understand the complexities of financial statements and how to use them to your advantage. Let’s start.
A Quick Breakdown of the Key Components of Your Financial Statement
The first and most important thing to know about financial statements concerns the three types: balance sheets, income statements, and cash flow statements.
Income Statements
This document shows how well your company’s finances did over a certain period (like the fiscal quarter). When you look at your income statement, I want you to pay close attention to these terms and what they mean for your business:
- Revenue: Your total sales and income for the period
- Cost of Goods Sold: How much it costs to produce the units you sold
- Gross Profit: Your total revenue minus the COGS
- Operating Expenses: Salaries, utilities, rent, and marketing costs
- Operating Income: Your gross profit minus your operating expenses
- Other Expenses and Income: Non-operating expenses like interest paid on debts and non-operating income like interest earned
- Net Income: Profit or the money left after paying all the expenses and taxes
If your income statement shows a negative amount for the net income, your business experienced a financial loss; a positive net income shows a profit.
Balance Sheet
Your financial status reveals more than just whether you earned a profit last quarter. This is where your balance sheet comes in—it shows the value of your assets, liability, and equity, giving you an overall picture of your business’s financial standing. Let’s take a look at how each of these plays a role in strategic financial planning:
- Assets: Your company’s resources, like inventory, accounts receivable, property, and cash
- Liabilities: Your company’s obligations, like loans, accounts payable, or accrued expenses
- Equity: Your interest in the business or your assets minus your liabilities
The balance sheet operates on a fundamental equation: assets = liabilities + equity. Get familiar with this equation so you have a better grasp of how to read a balance sheet.
Cash Flow Statements
We’ve made it to the last part of the financial statement. The cash flow statement shows the cash activity or inflow and outflow of cash. The inflow accounts for the cash your business receives (like payments from customers), and the outflow consists of the cash your business sends out (like paying bills). Like the other two parts, a cash flow statement shows the activity from a certain time period, whether quarterly or bi-quarterly.
Your cash flow statement should show the following types of cash flows:
- Operating Activities: Cash received from customers and other cash inflow that results from core business operations
- Investments: Cash flow dealing with buying or selling your business’s assets
- Financing Activities: Cash flow dealing with paying dividends, repurchasing stock, or repaying loans
- Net Cash Flow: How your cash changed during the statement period
Thanks to my years of experience in the financial management consulting game, I can tell you that managing your cash flow remains one of the most important things you can do for your business. I’ve seen small businesses achieve financial goals and reach new heights by being strategic about their cash flow management!
Key Financial Ratios: What They Are and How To Use Them
Key financial ratios are powerful tools that can help you analyze your business’s financial standing. Think of this as a way to give your business a routine health checkup. Every business financial advisory professional will tell you that you need to use four ratios:
The Profit Margin
The profit margin ratio shows how profitable your business is. You can find this by calculating how much profit you generate from each dollar of revenue.
I’ll give you an example: you sold 10 units of product at $10 each. It costs $7 to make each unit. Since you sold 10 units, your total revenue is $100, and your total cost of goods sold is $70, leaving you with $30 of profit.
That means that for every dollar of revenue earned, you made a $0.30 profit. Since you typically record profit margins as percentages, you would say that you earned a 30% profit.
The Return on Investment
You don’t need a business financial consulting expert to tell you that you should always aim for a high ROI when investing. This measurement helps you determine how fruitful certain investments are.
The Debt-to-Income Ratio
This ratio shows how much debt your business has compared to its income. Creditors often use this when issuing loans to determine how much of a risk you are. Higher debt-to-income ratios indicate greater financial risk.
The Current Ratio
Last but not least is the current ratio. This compares your existing assets with your existing liabilities to determine whether you can meet your short-term obligations.
Find Discrepancies and Address Them ASAP
One reason I urge business owners like you to be diligent in their financial statement analysis involves the ability to find discrepancies faster and address them sooner-when you do it right. No matter how tight of a ship you run, mistakes can happen. If you don’t address financial anomalies soon enough, you could face a much larger problem.
But regularly reviewing your financial statements does more than help you identify anomalies; it can also tell you when you need to fix your finances.
Let’s say that your financial statements over the last year show that your business has fallen short of the financial situation that you want it to be. You can see what areas need improvement by taking a close look at your revenue, expenses, investments, etc., and create a plan to boost your financial standing. Remember to always prioritize paying debts and pay special attention to your cash flow.
What Do Financial Statements Have To Do With Strategic Planning?
No strategic business plan is complete without a thorough financial statement analysis. What do I mean by that?
Well, the goal of strategic planning aims to improve operations, grow your business, and achieve various other goals. To do that, you need a solid financial plan, and your balance, income, and cash flow statements can help you do just that.
Your financial statements reveal how well your company performed last quarter, but you can also use this data to plan for the future! For instance, if you want to increase profits, your financial statements will reveal your most profitable products or services—and which ones aren’t.
You can use this information to tailor your operations and invest more resources in the profitable aspects of your business. It can also show you where you might need to cut costs. If you need a little extra help, don’t hesitate to schedule a meeting with a business financial consulting professional.
Using Financial Data To Secure Funding From New Investors
When providing expert financial consulting services, I see a lot of small business owners struggling to find the right investors because they don’t put up enough numbers. Yes, investors care about the type of business they invest in, but they also want to see numbers!
How profitable is your business right now? What does your projected revenue look like? Investors want to know they’re making a good investment in your business, so use your financial statements to give them specifics.
The Proof Is in the Numbers: Case Studies That Show the Effectiveness of Financial Analysis
I know what you’re thinking: Does this all really matter? Absolutely! To prove it, I’ll tell you a short story about a business I know you’ve heard of: Amazon.
In September 2022, Amazon’s financial statements revealed a staggering net loss of $3 billion. The year prior, it had earned a $19 billion net income, so there was clearly something wrong. By analyzing the financial statements, Amazon found that it earned less operating income for each dollar of its sales, leading to a profit margin decline.
If anything, this goes to show that businesses of all sizes can benefit from proper financial analysis.
The Bottom Line
As you can see, knowing how to decode and analyze your financial statements is essential, no matter what industry you’re in or how big (or small) your business is. You need to pay close attention to each part of the statement, from the balance sheets to the key ratios.
Comprehensive Business Finance Guidance Is Just One Phone Call Away
If you’re still not quite sure how to tackle your business’s financial statements, I’m here to help. You can give me a call or send me a message online to schedule a business financial consulting meeting. Let’s start a conversation today!
