As a business professional, accounting is a big part of keeping your company on the right track. Without accurately tracking income and expenses, managing invoices, and monitoring cash balances, it can be quite hard to properly budget and manage revenue in a productive way.
However, there's a big difference between diligently entering debits and credits and using your records to make strategic business decisions. Financial analysis is a major asset in operating a company to profitability, but even the basics can help you get ahead. Here's what to look for when generating financial statements in order to make the best business decisions for you.
Profit and Loss Statement
Also known as an income statement or P&L, a profit and loss statement is one of the most valuable options for analysis purposes. In essence, this report is a flow chart from top to bottom, from revenue to net income, of performance over a period of time. You'll find revenue at the top, whether by account or in total, followed by costs of sales, operating and SG&A costs, and any below the line expenses, like interest or tax expense.
While these statements may seem like an onslaught of numbers, being able to identify trends can help you see where your business is heading. For example, gross profit margin, or sales revenue minus cost of goods sold divided by revenue, can offer insight into how much money you're actually making on your sales. A low percentage means you're not making much profit, while a high percentage implies bigger gains. With these kinds of metrics, it's much easier to accurately evaluate your performance.
Cash in the bank is only one small part of determining your assets and your company's worth. Unlike a P&L report that summarizes performance over time, a balance sheet provides a snapshot of your financial health at any particular moment. It's named for its function: balancing assets with liabilities and shareholder equity. In essence, this means that current and long-term assets, like cash, equipment, and accounts receivable, must be equal to the financial obligations held by a company.
As with income statements, understanding the ratios that can be used to evaluate where you stand is critical. The current ratio, for example, divides current liabilities by current assets to determine liquidity, while ROA, or return on assets, divides net income by total assets to determine profitability.
Statement of Cash Flows
A statement of cash flows, also known as a cash flow statement, examines how income statement and balance sheet movement affect cash and cash equivalents. This activity is broken down by category, including operating, investing, and financing activities, to help monitor exactly where your cash is coming from.
Reading a statement of cash flows is largely useful in determining the source of your cash in relation to cash-generating activities. For companies heading in the right direction, most cash should come from operating activities. Analyzing the ratio of net income to operating cash flow can help with this determination; if cash from operating activities is regularly higher than net income, it's a good sign for your financial health.
Understanding the financial well-being of your business can seem overwhelming, especially when faced with a litany of reports provided by your accounting software, but a little knowledge in the basics of financial analysis can be extremely helpful. By knowing the ins and outs of basic financial statements, you'll be prepared to determine if your business is on a path toward success.