Financial Statements are More than Results

It’s easy to get lost in all the numbers when reading financial statements, particularly for those who rarely read them. By financial reports I mean not just the big three; i.e. the Balance Sheet, the Income Statement, and the Statement of Cash Flow. This also encompasses the supporting schedules and analysis as well.

Results Matter, But

Taking just the three main financial statements, it is important to asses the overall results. For the income statement look at profitability, but also consider the size of expenses for cost of goods sold, sales, marketing, administration, research and development, and other items. When looking at the balance sheet, consider how much cash there is, the accounts receivable balance, inventory levels, what the company owes others, and other things, depending on the type of business. For the cash flow statement get a sense of the main sources and uses of cash. The statement of cash flows is probably the most difficult for most to understand sufficiently to make sense. But when you do understand it, you can learn some useful things. That’s all well and done, however the “But” remains. That “but” is what I’m referring to when I say, Financial Reports are More than Results.

What Causes the Results

By using financial analysis it is possible to identify the drivers of different financial amounts. In Cash Management-It’s Not About the Cash Account I emphasized that the key to managing cash was not found in the cash account itself. The key was in managing inventory levels, accounts receivable, and numerous other things. Multiple things go into determining the cash balance, but the cash account itself is not really one of them to any great degree. You buy excessive inventory or allow accounts receivable to become considerably past due and your cash balance will reflect it. Likewise, production cost is driven by such things as payroll and benefits expenditures, depreciation, material usage and scrap expenses, along with more things too numerous to mention. If you use more people than are really needed to produce, pay more for materials, waste more than reasonable, then you will see the negative consequences in you production costs. It is like this for just about everything in a financial statement.

There’s More

The previous section talked about how different numbers on the financial statements are drive by numerous items and how analysis can help identify the actions needed to improve results. By the way, this is not a one-time process, but rather an on-going one of continuous monitoring and improvement. Now we need to dig a little deeper.

Financial analysis also includes the examination of key ratios. These include such things as current ratio, quick ratio, accounts receivable average days outstanding, inventory turnover, and much more. Even these can be further analyzed. For example, you may calculate that inventory is turning over on average four times per year. However, remember this is a gross number. It can be extremely helpful to examine turnover on an item by item basis as there may be some items that turnover extremely fast and others that take a year or more. It’s those slow turning items that present a great opportunity to improve financial results. Accounts receivable is similar. Go deeper than just the overall days outstanding and identify those customers who are the fastest and slowest to pay. The fastest payers may represent an opportunity to sell more, while the slow payers may be ones you need to monitor more closely or even consider if you want to do business with them. Regardless of what you are analyzing, it is helpful to have some techniques to speed the process. An example is the 80/20 or Pareto Principle. This can be used to identify such things as the 20% of inventory items that product 80% of your sales, the 20% of items that are reducing your overall inventory turnover, the 20% of customers who produce 80% of your sales, etc. The 20% and 80% are approximate numbers, but hold fairly consistent. Your may find your situation to be 30% produce 80% of a particular results, but I think you get the drift.

AimCFO can help you have a clearer understanding of why your financial statements are more than results, as well as help you identify key drivers of the results and actions you can take to improve them.

If you want to know more, contact AimCFO – Contact

As always, your comments are welcomed.

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