Opinion: Financial statements tell a story – are you listening?

Kelley K. Self

Business owners use a vast number of methods to help determine the performance of their business. From tracking sales quotas, marketing metrics, call volume, or search engine optimization to customer service, social media, online reviews and employee feedback, the options are nearly endless. But how well do owners and managers use or understand their financial statements?

Financial statements report the position and financial activities of a business, identify successes and failures, and are an integral part of running a business. Creditors, suppliers and investors use financial statements to determine credit worthiness, projections, sustainability and liquidity, as well as transparency and trust in management. The balance sheet, profit and loss and cash flow statements are more than mere compliance reports – they are management tools. Each provides valuable information, and an accounting degree is not necessary to understand them.

The balance sheet reports a company’s assets, liabilities and equity as of a given date, normally at month, quarter, or year-end. Assets include cash, inventory, balances due from customers, investments and physical property such as buildings and equipment. Liabilities include obligations and debt such as bank loans, amounts due to suppliers and taxes owed. Equity is the owner’s stake in the company and represents what would be left if all the assets were sold and the company paid off all its liabilities.

While the balance sheet is a snapshot at a point in time, the profit and loss statement is a summary of activities over a given time period. This is normally a year or portion of a year, such as a month or quarter. It reports the total sales revenue during the period and the cost of selling those goods or services.  This net amount is known as the gross margin. Operating and overhead expenses are then subtracted from the gross margin, producing total n et income, often referred to as the bottom line.

The cash flow statement summarizes the sources and uses of cash over a period of time into three areas: operating-delivery of regular goods and services: investing-purchasing or selling of assets and financing-equity and the acquiring and repayment of debt. This statement identifies where a company’s cash came from and how it was used.

Many businesses tend to focus on the bottom line; however, each statement tells an important story. Understanding the balance sheet helps determine a company’s operating needs. Knowing where your cash is flowing to and from assists in short- and long-term planning and provides insight into the operating efficiency and financial health of a company. Studying the correlation of revenue and expenses on the profit and loss statement helps analyze profits and therefore, the bottom line. It is important to note that the three statements are connected – if one of them is wrong, they are all wrong.

When financial statements are prepared in comparison to prior periods, they begin to paint an even bigger picture, revealing trends. From cash crunch times, product seasonality, and economic impact to wasteful spending or areas in need of increased spending, analysis of financial statement trends highlights focus areas. Owners and managers can then begin to drill down further, ask questions, find answers and make strategic decisions.

Financial statements can be designed to provide condensed or expanded information including additional metrics. Ratios can also be calculated from financial statements such as debt to equity, asset liquidity ratios, and return on investment. Having advisers, bookkeepers and accountants preparing or reviewing the financial statements also establishes a level of confidence in accurate, complete and consistent financial reporting. While ratios and supplemental reporting can help owners make informed decisions, just knowing how to read each statement and routinely doing so provides an owner with financial insight into the business which may otherwise be overlooked.

With today’s technology, business owners have an arsenal of tools available to help operate, market and measure their business. The financial statements report on the results tell a story. It’s an important – story – one every business owner should want to hear.

Kelley K. Self is a consulting specialist for Elliott, Robinson & Co. LLP. She can be reached at
kself@ercpa.com.