Preparing financial reports and statements is an essential task for every business. These reports can provide crucial information that will help you make informed decisions regarding your business’ finances and overall operations. In fact, they are good indicators of assessing the financial health of your company.
But in order to use them properly, one must know the role of each financial statement in the report and how to interpret the data they generate. Otherwise, every financial report will only remain a written record that doesn’t make any difference at all.
Unfortunately, it’s a problem for many business owners. They have all the necessary data, but they don’t know how to analyze them. If you have the same dilemma, keep on reading and learn how to make sense of your company’s financial reports.
Get To Know The Core Financials
It is imperative for business owners to know your company’s cash, profit, revenue, and expenses. That is the purpose of a financial report. But the first step is to understand it by reading and knowing the financial statements. Once you have an idea of what each statement represents, you can better understand how they reflect your business’s performance.
Here are the core financials that are critical to seeing the general picture of your business.
Income Statement
An income statement shows the amount of revenue your business has generated within a specific period. It is one of the essential elements of your financial report as it highlights the company’s profit and losses.
By reading the income statement, you can discern your business activities and financial trends. The numbers in this document will affect your marketing efforts, pricing, and expense management.
Balance Sheet
The balance sheet illustrates an overview of your company’s financial situation compared to its assets, liabilities, and equity. It is often considered a more significant financial indicator since it provides the business’s most recent financial data.
Basically, this document gives a rundown of what your company owns and what it owes. When your balance sheet has more liabilities than assets and equity combined, you have to look more closely at your business’s capacity to pay its debt obligations.
Cash Flow Statement
Cash flow refers to the money going in and coming out of your business. It also incorporates information from both the income statement and balance sheet. Note that this financial statement depicts the true picture of a company’s financial health. Typically, it will warn you when you have any issues with missing payments, such as payroll.
Many businesses fail because of poor cash flow. Thus, make sure to be mindful of the inflow and outflow of cash in your business.
Utilize Different Financial Analysis Techniques
Financial analysis is a vital component of your business. It helps you examine historical financial data to gain information about the financial health of a company. The income statement, balance sheet, and cash flow statement are only raw data of your business’s financial performance. You have to utilize analytical techniques to process them.
Remember that there are several analyses that you could perform once you compile the core financials, such as their trends, strengths, and weaknesses. But here, we’ve covered three commonly used financial analysis techniques.
Vertical Analysis
Also known as common-size statements, vertical analysis is utilized to show the relative sizes of the different accounts on a financial statement. Every line item on a financial statement is entered as a percentage of another item when performing a vertical analysis.
Let’s say you do a vertical analysis on a specific income statement. It will indicate the top-line sales number as 100%, and every other account will show as a percentage of the total sales number. With percentage forms, businesses can easily compare two similar statements from different periods or even between different companies.
It’s worth noting that vertical analysis is excellent at showing what is happening within your company’s financial statements. For instance, it can tell you whether costs are rising and profits are declining. However, it cannot provide answers for such occurrences.
Horizontal Analysis
Horizontal analysis can show changes in the amounts of corresponding financial statement items over certain accounting periods. That’s why it is useful in spotting financial trends and growth patterns.
There are several options to approach your horizontal analysis. But one is a direct comparison, which is comparing the results of one accounting period to another. Let’s say your 2019 revenue was $25,000 and your 2020 revenue was $30,000. Making such a comparison allows you to rapidly view any positive or detrimental changes from period to period.
Financial Ratio Analysis
Financial ratio analysis is a tool that you can use to gather valuable insights into your business’s profitability, solvency, efficiency, liquidity, coverage, and market value. Generally, it conveys essential information about the relationship of one metric to another.
The information you can gather from financial ratio analysis is most beneficial if you have to make financial decisions that include external parties like investors. It makes financial analysis possible across your company’s performance over time while comparing it to another within the same industry.
What To Look For In Your Financials?
In order to make more sense of your company’s financial reports, here are essential factors that you have to look for when performing financial analysis.
- Historical data. It is essential for you to look at what has happened over the last month, quarter or year. It can help you track improvements over time and give you insights, which will eventually become a key driver for your business growth.
- If your business financial reports are consistent, you can accurately compare them between periods. You can assess progress by comparing historical data and the current financial performance or your business goals and actual results.
- Potential Problems. Your periodic financial reports serve as your company’s realistic gauge. It can provide visibility by spotting potential problems and making solutions even before they occur.
Important Reminders
While financial reports are important to monitor your business’s financial performance, they are also required by the law. If your company has more than 500 common shareholders and $10 million in assets, you may be required to file financial reports with the SEC (Securities and Exchange Commission).
But in some cases, private companies would buy back stock from their current shareholders to maintain the number of individuals who own stock under the 500 limit. Nevertheless, shareholders who acquire 5% or more of the company’s shares must report to the SEC with the Posen Simon Ownership Acquisition Statement.
Takeaway
Analyzing your business’s financial reports isn’t an overnight task. There is no shortcut to make you an instant expert in your company’s finances. In truth, most business owners learn financial analysis as they go in their daily business operations. But the key is to pay more attention to your business’s historical data, progress, and potential problems.
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