4 Pillars of Understanding Business Finances
Guest blog from Melissa Clemo of MC Business Strategies.
An essential component for any business owner is understanding their financial statements. As a trusted business financial coach, it is our responsibility to make sure that you understand various financial statements, what they mean and how important they are in making critical business decisions. Financial statements are significant documentation helping you as the owner, to know your financial strengths and weaknesses - allowing you to increase your profitability and strategically map out your business’s future.
Quick overview - what are the important financial reports that should be reviewed and analyzed, either monthly or quarterly for positive strategic financial planning of your business?
Balance Sheet
Profit and Loss
Cashflow
Ratio Report
Unfortunately, business owners who don’t really understand what their numbers mean, take the chance in exposing their weaknesses and will often make incorrect assumptions about their business - potentially creating a negative financial impact.
Income Statement - aka - the Operating Statement, or a Profit and Loss Statement (P&L). The income statement is defined as the statement that displays company revenues, costs, gross profits, selling and admin expenses, other expenses, taxes, and net profit. Creating a projected income statement over the course of a twelve-month period based on forecast, helps the owner keep cost and revenues on track. In addition, the income statement indicates the trends when analyzed month over month… If the company creates a product, the gross profit is the first number to review, as it’s the revenue minus the cost of goods sold. The income statement continues on, to show all expenses for the month; the increases and decreases in net income; and how much money is left to grow the business, pay debt, and provide to the owners.
Balance Sheet - is defined as - a statement of the assets, liabilities, and capital of a business or other organization at a particular point in time, detailing the balance of income and expenditure over the preceding period.
Assets are what you own
Liabilities are what you owe
Capital/Net Worth is what is left over
This report shows all the ins and outs of your business money. Did you receive money, pay a recurring loan payment, it’s all in here. Please don’t be confused because this does not show the monthly income or monthly expenses. The Balance Sheet will report the value of your business. The balance sheet does not show the quality of assets, contingent liabilities, or operating obligations. The core purpose of the balance sheet is to keep you on track each month in terms of what you own, what you owe, and what is leftover.
The Cash Flow Statement is defined as a statement that defines the financial health of a company as it reports all cash inflows a company receives from its ongoing operations and external investment sources. It also includes all cash outflows that pay for business activities and investments during a given period. Cash is the number one thing needed to run a business, the cash flow statement indicates if a company is cash poor or rich. A company could be reporting a profit but not have a positive cash flow, here is why the statement of cash flow is so important to your business. The statement of cash flow is a critical component of your financial statement portfolio. This statement can show how a business can cover day to day activities, pay current debts, maintain the operation of the business and potential business growth. Potential business growth? Yes, this statement will also help a business owner know if they can acquire more working capital, this includes material and additional employees. Growth usually includes an additional infusion of funding, the statement of cash flow will track where that infusion comes from.
Income statements = shows the portion of payments applied to interest
Balance Sheet = shows the reduction in the loan principal
Cash Flow Statement = shows both sides of the payment together
When the cash flow statement is broken down month over month, it shows the business’s ability to keep and create cash. By monitoring this statement, owners can potentially see issues arising and create strategic plans to fix the issues. The cash flow statement shows, cash coming in, cash going out, and cash that stays.
Ratios indicate the strengths and weaknesses of the business’ financial standing. Lenders tend to base loan qualifications on ratios as well. Ratios are also valuable when measured against industry standards and used for trend analysis. Make sure when evaluating industries standards you are comparing similar revenue ranges. Ratios are calculated using all three of the statements discussed above, Balance Sheet, P&L, and Cash Flow statement.
Asset Management Ratios - indicates how productively assets are being managed:
Accounts Receivable Turnover Ratio - days to collect receivables
Inventory Turnover Ratio - how many days to sell your inventory
Liquidity Ratio - indicates how cash rich a business is
Working Capital Ratio - does the company have enough cash to pay bills
Quick Ratio - what assets can be turned into cash quickly
Current Ratio - shows the ability to pay short term debt
Debt Management Ratio - indicates who owns more of the business, the owner or lender
Debt to Worth Ratio - shows how has more invested in the business
Accounts Payable Turnover Ratio - how fast are payables paid
Profitability Ratio - indicates the business’s ability to in making a profit
Profit Margin on Sales Ratio - net profit per dollar of sales
Debt Service Ratio - ability to pay off term debt
Questions? We can be your business financial manager partner and assist you in understanding your business growth strategy, reach out for a free consultation.
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