subject line: Fourth Course – Grow Your Business With Accounting Challenge
Hello [newsfield name=”name”],
How are you? We are winding down to the end of this short course, but we still need to go over a few things. Today we are going to jump right in and talk about ‘How to read your business financial statement’.
Financial statements are the report card of a business over a period which could be monthly, quarterly or annually. As a small business owner, you need to understand how to prepare, read and analyze financial statements so you can get a full and accurate understanding of your finances.
Financial statements will tell you how much money there is, how much debt is owed, the income coming in each month, and the expenses going out of the door.
What are these financial statements? They are
- Income Statement
- Statement of Financial Position or Balance Sheet
- Cash Flow statement
The numbers in a company’s financial statements reflect the company’s business; it’s products, services, and macro-fundamental events.
These numbers and the financial indicators or ratios derived from them are easier to understand if you can visualize the underlying realities of the fundamentals driving the quantitative information.
For example, before you start crunching numbers, it’s critical to develop an understanding of what the company does, its products and/or services, and the industry in which it operates.
There are two ways to read financial statements:
- Absolute terms
- Ratio Analysis
In reading financial statements in ABSOLUTE TERMS, the numbers are looked at singly, and in comparisons to previous period or against the same period in the previous year.
In reading the Income Statement, the following questions may be asked:
- How much revenue do we make this month?
- What is the profit?
- What is the total overhead cost?
- What is the highest overhead cost incurred?
- And others
All these can be compared to immediate previous period or the same period in the previous year
In reading Statement of Financial Position
- What is the net book value of the Property Plant and Equipment?
- What is the level of account receivable, inventory and cash?
- Do the current assets cover current liability?
- Is the long-term liability increasing or decreasing?
- Is the business ploughing back profit?
In reading Cash Flow Statement
- What is the amount of cash generated from operations?
- How much cash is re-invested in the business?
- What is the source of the financing activities?
Answers to all these questions can be found on the face of the financial statements just by taking time to look at the figures.
Reading financial statement using RATIO ANALYSIS provides and in-depth details that can help any business to navigate through mucky waters. However, ratio analysis requires a good knowledge of mathematics.
I will not go into details, but will let you know the five major categories of financial ratios that can help your business
- Leverage Ratios measure capital structure e.g debt/equity
- Liquidity Ratios show the ability of a business to pay its bills as they occur, based on its current assets versus current liabilities. It enables a business know how much resources it has to meet payment of bills. g current assets/current liabilities
- Operating Ratios show efficiency of management and a company’s operations in utilizing its capital, especially through the cash conversion cycle in pursuit of profit. e.g cost of goods sold/average inventory
- Profitability Ratios are designed to give you an idea of how lucrative it is relative to some particular metric e.g ROI profit/capital
- Solvency Ratios indicates whether a company’s cash flow is sufficient to meet its short-and long-term liabilities. The lower a company’s solvency ratio, the greater the probability that it will default on its debt obligations.
Net profit after tax + non-cash expenses/short-term liabilities+long term liabilities
These areas are technical for a non-accountant, just know that those ratios exist. Your accountant will always help you if the need arises.
That’s it for today’s lesson. I hope you find it helpful and now have a
better understanding of enormous information you can generate from your business account and how you can use these information to your advantage.
Don’t forget to keep an eye out for my next email. There will be some great stuff in your last lesson.
Yours in enhancing your profitability and growth
J. Taiwo Popoola