Financial statements and business success
What are the benefits in business owners understanding financial statements? There is no doubt that the current recession is as long and as hard as we’ve seen for many years. And hopefully we will not get to see again for quite some time. If you are a business owner whose business is not making a profit and you don’t have the capital to invest and keep the business, going you may be wondering about your options.
The first option is to take a real assessment of where you are at. One of the best ways of doing this is to talk with your accountant. Make sure your accountant is not simply filing your tax return to meet compliance but actually helps you look behind the numbers and understand how your business is performing.
What do you need to know?
Most business owners understand their gross sales. Some are adept at using this number to explain the success of their business. For example, have you spoken to a business owner that said “Sales are up 20% on this time last year.” They say this with great pride but that doesn’t tell the full story.
Some business owners can tell you the net profit of the business. Net profit is simply what they pay taxes on or gross sales less cost of goods less expenses. Some business owners like to say “Our bottom line was up 10% compared to last year.” This is good news but that doesn’t tell the full story.
A few business owners can get into their financial statements and understand what’s happening in their business. For this business owner it’s the Profit and Loss Statement. If they prepare this document themselves they know what’s going on, but most business owners have a resource such as a family member or at least a bookkeeper to handle these details for them. However, that leads to a couple of points.
The first point is that theft in small businesses, due to the recession, is at its highest in many years as the person handling the books is able to cook the books by stealing funds which the owner doesn’t know about. They can steal funds through a false invoice or buying certain goods, have the business pay for them and then take the goods back and get a refund and keep the money.
There are many creative ways for someone to find money if they want to. So how does a business owner protect themselves? One of the ways is for the business owner to do a line by line check of the profit and loss statement at least on a monthly basis. Any item that appears and the owner can’t remember what the expense was for can be challenged to find an acceptable answer.
It can then be wise to do random tests to make sure all expenses can be verified such as checking to make sure that new computer the sales person needed is still around or that special order of inventory was needed and did arrive etc. Testing the monthly profit and loss followed up with random checks creates good discipline and helps the owner stay on top of the critical aspect of the business but this doesn’t tell the full story of the financial health of the business.
The health of the business is really revealed by working with the Profit and Loss Statement and the owner that can read and understand the Balance Sheet.
The balance sheet is the place that explains how the money coming into and going out of the business was used. It shows what’s owed and it shows what the business owns (or the assets of the business). It reveals the owner draw and investments and basic information about the Accounts Receivables and Accounts Payable and how they are tracking. If Accounts Receivables are growing then Accounts Payable may also grow but they should keep their ratio’s consistent.
If a business owner can understand a healthy balance sheet they are well on their way to maintaining and growing a successful business. Understanding a balance sheet doesn’t mean you need to become a CPA. It means you need to ask questions until you “get it.” Most business owners shy away from understanding the balance sheet as it’s too confusing. However, if you ask the same question month after month it will eventually makes sense.
Are you thinking about selling your business? Would you like to know the value of your business? If you would like more information please visit my website Business valuation.
For more immediate help you are welcome to send an email to Andrew Rogerson or give me a call on 916 570-2674.