What do the numbers mean?
When you look at your financial statements do you know what you are looking at? Do you see the story behind the numbers? Can you see beyond the profit or loss at the bottom of your Income Statement?
So many business owners look only at the profit or loss of their company and are missing out on what is really happening in their business. Each report tells a story.
The Balance Sheet shows what a company owns and owes. It will show where cash is it, how much has been invested in assets, and how much debt there is. Looking at the debt to equity ratio (liabilities/equity) shows how leveraged the company is. The current ratio (current assets/current liabilities) shows a company’s ability to cover their current obligations.
The Income Statement shows the profit or loss of a company for a given time period. It will show sales revenues, cost of sales, and operating expenses. If compared with prior months or years, trends and issues can been seen. The gross margin (gross profit/sales) should be consistent unless a major change has occurred. If no major change has occurred and the gross margin has a large fluctuation there may be an issue to uncover.
Cash Flow Statement
The Cash Flow Statement shows the ins and outs of cash. It will show the actual cash happenings of a company. One may think they can get this answer from the Income Statement but in most cases the Income Statement is based on accrual accounting which shows the revenues and expenses as they occur not actually when the cash is being exchanged. For those that wonder why they show net profits but no cash, the answer may be found here.
In utilizing both the Balance Sheet and the Income Statement many more stories can be told. By calculating the AR Turnover Rate (Sales/AR) one can see how quickly receivables are being received. Or by calculating the AP Turnover Rate (COGS/AP) one can see how quickly payables are being paid. Other ratios that can be calculated to tell a story would be the Inventory Turnover Rate, Return on Investment, and Return on Assets ratios.