Your Financial Statements in a Folder – Do You Know What They are Telling You?

Your Financial Statements Exist to Serve You

Do you print your financial statements from your bookkeeping system every month only to have them tossed in your desk, never to be looked at again?
 
You are not alone!
 
Many entrepreneurs engage in this activity and believe they “looked at them – so what else is there to do?”
 
However, my question for these individuals is always – do you know how and what you are looking at?
 
Let’s look briefly at two most important of your financial statements that your business has (or frankly should have) available to review at any given time.

Profit/Loss or Income Statement

The most important financial statement to the business owner is the profit/loss or income statement. This is because it tells if the business is profitable. It also can tell you if your cost of sales and expenses are under control and other useful information.

Let’s look at the 3 major areas of the profit/loss or income statement that include revenue, cost of sales and expenses:

Revenue:

refers to what the business earns and refers to income that is earned from goods and services sold to customers/clients. This is the normal day-to-day business that your business provides.

Cost of Sales:

refers to the direct costs associated with generating revenue and refers to the direct labour and materials that the business incurs in order to produce or provide a specific product or service.

Expenses:

refer to the overhead and administrative costs the business incurs and includes the costs associated with operating the business. Generally, we are speaking to general and administrative expenses, the expenses that are incurred even if the business generates no sales. This is the part of the business that needs to have careful attention given to it. In the absence of budgets and good business sense, overspending can be the financial ruin of a good business.

The net income/loss shown on the income statement is also shown in the equity section of the balance sheet.

Brief Analysis of Your Profit/Loss Statement

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While there are many types of analysis that you could embark upon, there are two areas that you should test on a monthly basis – these include:

Percentage (%) increase/decrease in Sales

– using the current month that you wish to know where your sales are when compared to the same month in a prior year.

What is the calculation?
 
Sales This Year (for a particular month) – Sales Prior Year (same month) = Increase/Decrease in Sales. Then using this result, divide this by the Sales from the Prior Year (same month).

Where do the numbers come from?
 
They come from the income statement.

Show me how.
 
For example, if the Sales This Year in the month of June were $ 25,500.00 and the Sales for the Prior Year in June were $ 21,500.00 – then the calculation is:

$ 25,500 – $ 21,500 = $ 4,000.00.

Then, $ 4,000 / $ 21,500 = 19% increase in sales.

What does it tell me?

It tells you how much sales (revenue) has increased from last year to this year for the month of June, that is 19%.

What else should I know?
 
The higher this percentage – the better.

Net Profit Margin

– this calculation is used as a measure of profitability and to evaluate your business performance.

What is the ratio?
 
Profit Margin = Income Before Interest and Taxes / Net Sales (Revenue)

Where do the numbers come from?
 
They come from the income statement.

How is it calculated?

Take the total income before interest and taxes from your income statement and divide it by the net sales (revenue) also from the income statement.

Show me how.
 
For example, if the total income before interest and taxes is $ 147,000 and your net sales(revenue) are $ 22,000 – then the ratio is:
 

$ 147,000 / $ 22,000 = 6.68 that is expressed as 6.68%.

What does it tell me?
 
It tells you how much net sales (revenue) is left after all expenses have been covered.

What else should I know?
 
The higher the profit margin is – the better.

Balance Sheet

Financial institutions, investors and other interested third parties always pay close attention to the equity account to observe the investment value of the business.
 
You as the business owner should look to your balance sheet for other reasons that include the status of the assets, liabilities and equity parts of your business.

Let’s look at the main categories that are found in the balance sheet:

Assets:

refers to what the business owns.  This includes the cash the business currently has on hand in addition to cash it expects to collect in the short-term (these are current assets.)  It also shows fixed/capital assets and includes assets that are used in the business in order to it to operate it and can include a vehicle, building, equipment or tools; it includes items that are would take longer than one year to convert to cash.

Liabilities:

refers to what the business owes.  This refers to what the business is obligated to pay—it is what it owes. This includes all the debts the business has. Generally, the two categories of liabilities that you will use are current liabilities, those obligations that are due within one year and long-term liabilities, those debts that must be paid in a term longer than one year.

Equity:

refers to the net worth of the business. Simply put, if all available assets were used to pay all outstanding liabilities, the remaining amount would be the equity in the business.   Equity is derived from the three sources—net profits from earlier periods that are carried forward to the present, current profits/losses and money invested in the business by you (the owner).  Equity accounts include Owner’s Equity/Capital-refers to the amounts the owner’s invest in the business.  Owner’s Draws—refers to amount withdrawn to pay the owner.   Note that payroll accounts or reimbursement expenses to owner’s should not be included in equity.

Brief Analysis of Your Balance Sheet

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Again there are several kinds of analysis that you could do regularly, but the following two ratios you should test on a monthly basis:

 
Calculate:

Current Ratio

– it will show the overall financial condition of your business.

What is the ratio?
 
Current Ratio = Total Current Assets / Total Current Liabilities

Where do the numbers come from?
 
They come from the balance sheet.
 
How is it calculated?
 
Take the total current assets from your balance sheet and divide it by the total current liabilities from the balance sheet.

Show me how.
 
For example, if the current assets are $ 4,000 and your current liabilities are $ 2,000, then the ratio is:
 

$ 4,000 / $ 2,000 = $ 2,000. Therefore, the ratio is 2:1.

 
What does it tell me?
 
It tells you by how much that your current assets can cover your current liabilities. Therefore, in our example above, your business is able to cover its current liabilities 2x with its current assets. This is a healthy position to be in.
 
What else should I know?
 
The higher the current ratio is – the better.

Debt-to-equity Ratio

– is to evaluate the financial leverage of your business.

This is a calculation to evaluate the financial leverage of your business; that is the amount of debt your business has, when compared to equity.

What is the ratio?
 
Debt-to-Equity Ratio = Total Liabilities / Total Shareholder’s Equity

Where do the numbers come from?
 
They come from the balance sheet.

How is it calculated?
 
Take the total liabilities from your balance sheet and divide it by the total shareholder’s equity from the balance sheet.

Show me how.
 
For example, if the total liabilities are $ 25,500 and your total shareholder’s equity is $ 100,000 – then the ratio is:

$ 25,500 / $ 100,000 = 0.25. This is often expressed as 0.25 to 1.

 
What does it tell me?
 
It tells you that you have $ 0.25 cents of other people’s money (your creditors) in the business for every $ 1.00 that you have invested in your business.  Since shareholder’s equity is the excess of assets over liabilities – then if you needed to, there are assets remaining to cover outstanding debts.

What else should I know?

 
The lower the debt-to-equity ratio is – the better.

Although this analysis is by no means complete, it does provide a brief alternative for what you should be doing as a minimum every month with your financial statements. So why not try this at the end of this month?

Would you prefer help with this? 

Let us help you to calculate these and other important business ratios –

Email us at info@birdseyeaccounting.ca

Call us at 780 – 901 – 9494

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