Do you truly understand your company’s financial statement?
Having a strong understanding the three components to your financial statements — the balance sheet, income statement and statement of cash flows — allows you to make wise business decisions.
The Balance Sheet includes a listing of company assets, liabilities, and net worth to create a snapshot of the organization’s overall financial health.
Net worth or owners’ equity is the extent to which assets exceed liabilities. Because the balance sheet must balance, assets must equal liabilities plus net worth. If the value of your liabilities exceeds the value of the assets, your net worth will be negative.
Common balance sheet ratios worth monitoring include:
Growth in accounts receivable compared to the growth in sales.
If receivables are growing faster than the rate at which sales are increasing, customers may be taking longer to pay. They may be running into financial trouble, or finding quality issues with the products or services.
Growth in inventory vs. the growth in sales.
When inventory levels increase at a faster rate than sales, the company is producing products faster than they’re being sold. This can tie up your cash. Moreover, the longer inventory remains unsold, the greater the likelihood it will become obsolete.
Growing companies often must invest in inventory and accounts receivable, so increases in these accounts don’t always signal problems. Typically, jumps in inventory or receivables should correlate to rising sales.
The ratio of current assets to current liabilities.
If this ratio falls below 1, the company may struggle to pay bills coming due. Some business experts believe a current ratio of less than 2:1 is problematic.
The income statement shows sales, expenses, and the income or profits earned after expenses over a given period.
Key performance indicators track when reviewing your company’s income statement include:
- Gross Profit: income earned after subtracting the cost of goods sold from revenue.
- Cost of goods sold: the cost of labor and materials required to make a product.
- Net income: the income remaining after all expenses (including taxes) have been paid.
Like the balance sheet, the income statement can reveal potential problems. It may show a decline in gross profits, which means production expenses are rising more quickly than sales.
Statement of cash flows
This report shows all the cash flowing into and out of your company. For example, your company may have cash inflows from selling products or services, borrowing money and selling stock. Outflows may result from paying expenses, investing in capital equipment and repaying debt.
Although this report may seem similar to an income statement, its focus is solely on cash. For instance, a product sale might appear on the income statement, even though the customer won’t pay for it for another month. But the money from the sale won’t appear as a cash inflow until it’s collected. To remain in business, companies must continually generate cash needed to pay creditors, vendors and employees. So you should watch your statement of cash flows closely.
The importance of strong financial reporting
Accurate financial reporting can help to understand your company’s financial workings and can help you to make better strategic choices for the long term.
MJ’s small business specialists utilize the latest cloud-based technologies to help small business owners generate solid financial reports that guide daily business choices. Whether you require strategic guidance, planning, or a full outsourced solution we can help in some – or all – of the following areas: general ledger entry, financial statement preparation, payroll, bank reconciliation, and filing of returns.
Email our team today if you need help setting up your financial reports and key performance metrics.
Tene’ Thomas is a licensed CPA with more than 20 years of technical experience in tax compliance and accounting services. As partner of the tax and small business solution practice, Tene’ serves a myriad of industries including nonprofit organizations. This diverse knowledge allows her to provide high quality and comprehensive services to clients with these specific tax and accounting needs.