Understanding Financial Statements
Financial Statements – are they relevant to my business ?
July Update Written by: Gavin Beretta FCIS, MBA, CMT – Partner / Lecturer of Biz Facility
Over the years, I have come across many a practitioner / entrepreneur who runs their practice / business and yet rarely glances at their annual financial statements – those things you do for SARS, or possibly the bank manger, but which cost you an arm and a leg.
Just the other day, in quoting a business, I glanced at the prospect client’s Income Statement and remarked that they had a reported loss of over a R 100k for the prior financial year. The client was so surprised at this news; and went into mild shock for a number of days thereafter – no one had told her this news, even through the Financial Statements were in her possession for a number of months.
Yet, by learning some simple but effective tools, the above scenario can be avoided – even if just to identify differences from the norm, in order to ask your Accountant some penetrating questions.
Financial Statements are another tool in the entrepreneurs’ arsenal in managing their business, and it should be so in your business as well.
As I explain to my clients, accounting is the language of business, and everyone in business, should be able to read the language – Financial Statements.
The Financial Statements consist of:
- Statement of Financial Position (old Balance Sheet)
- Income Statement
- Cash Flow Statement
- Change in equity Statement
- Notes to the Financial Statements
- Directors / owner’s report
In our training that we provide to clients, we focus on the operational side of the business, which by reading the above statements we can determine how efficiently the owner is running their business.
In the Income Statement for instance, the key figure to focus on is Operating Profit. This is a critical figure in all businesses. If this figure is positive it tells us that the business is covering all costs, including overheads – a good place to be!
By then comparing this figure to the Cash generated from Operations figure, reflected in the Cash Flow Statement, one can determine how effectively the business is converting profits into cash.
If there is a negative cash flow at this level, the most likely problem is that cash is “stuck” in Working Capital, which we find in the Statement of Financial Position.
In my experience, many SME’s become unstuck as a result of inefficient working capital management, with the result, despite the business making profits; there is always a problem with cash flow.
By using the Financial Statements, as described above, one can identify the source of the problem, and then implement corrective action to resolve the situation.
The good news is that you don’t need to wait for your annual financial statements to make the above type of decisions – you can ask your accountant to provide this information on a quarterly basis – this will give you more than enough time to identify issues as they begin to surface, and to implement corrective actions.
A service I provide my clients is a regular analysis of their businesses, with a detailed report identifying the relevant key drivers of their business – these reports allow our clients to be fully aware of their Financial Health of their business, and can quickly respond to request from external stakeholders for feedback on their business.
By using Financial Statements in this way, they become a working tool and an aid in decision making – and when you are a SME, you need all the assistance you can get!
*Make Financial Statements a working document, and not something grudgingly done for the authorities.
Learn about our 2 Day Workshop – Understanding Financial Statements – HEREShare