How to Turn Your Financial Data into a Story Worth Reading
Financial statements taken individually only tell part of a company’s story. Together, however, they can tell a clear story about an organization’s financial health and profitability.
Accurate financial statements reveal a lot of information, all of it actionable when looking at the overall picture, for example:
- There may be too much working capital on hand that could be invested instead. Alternatively, the company might be investing too much and not keeping enough in reserve.
- The company is investing too quickly to accelerate growth and not recouping that investment efficiently enough which affects profitability.
- The cost of goods is too high, leading to profit margins that are too slim.
- Material prices are increasing faster than the company is raising prices.
Let’s look at the various financial statements CPAs and CFOs should be examining for business clients or the companies for which they work.
The balance sheet provides a financial snapshot of the company’s position in terms of assets, debt and equity at a specific moment of time — the month, quarter or year. It is recommended to always compare the balance sheet at two separate points in time to reveal company trends and ratios.
- Review fluctuations in account balances and attach explanations. Look at accounts with material differences such as inventory, capital expenditures and accounts receivable.
- Compare actual results to projected balances. This is an excellent guide to define necessary course corrections. Look for the story behind things such as inventory levels and turnover; and accounts receivable increases due to aging or increased sales.
- Compare the company to others in the same industry. How does it stack up against the competition in the local or regional market, or in the sector? Go to industry groups that publish data to find businesses of comparable size, market and ownership type, and complete a ratio analysis to see how the company compares and to discover areas of opportunity.
The income statement tracks data monthly, quarterly or annually. It’s best to compare income statements over different periods of time to gain further insights into the company’s profitability. Trends and ratios to look at include the following:
- Profit or loss over the time period. Look at year to date as well as last year versus this year to date. Compare actual results to your budget as well.
- Margins. Is the business doing as well as expected? Is there room to cut back if margins have been suffering? Are market conditions affecting business? If margins are lower due to vendor pricing, could the company get better pricing from its suppliers?
- Expenses. Have expenses increased? If so, do you know why? Look at major expenses: payroll, utilities, employee benefits and insurance. As with the balance sheet, compare the company’s performance to others in the same industry. Look at trends outside of the business that may affect income, including economic, political and global factors.
Use all the income statement information to create informed financial projections and make operational decisions that are needed to align income and expenses with business goals. The numbers here might be indicating that it’s time to find a new vendor or negotiate better pricing, increase the company’s prices for goods and services, or drop an unprofitable line of business.
Statement of Cash Flows
It’s important to know how cash moves through the business. The statement of cash flows analyzes increases and decreases in assets such as cash, inventory, receivables and liabilities such as payables to vendors, bank loans and credit cards. Review the changes and explain the cause.
In theory, a well-operating company should see its cash increasing, with timely collection of receivables, bills paid on time and a reserve in the bank. If that’s not the case and cash is decreasing, look for factors to explain this.
On the positive side these may include the following:
- Capital investments such as new equipment, infrastructure upgrades, physical expansion or a new location
- Additional staffing
- Seasonal inventory push
- Shareholder distributions
Negative trends that should raise red flags and require action include the following:
- Steadily declining cash balance
- Too much debt that cannot be supported at current income levels. Is the company borrowing to support operations rather than to achieve growth?
- Increasing and aging account receivables
- Operational inefficiencies — stale inventory, overstaffing, outdated processes or duplication of tasks that are out of alignment with the company’s standard operating procedures manual
Who is Reading the Financial Statements?
Aside from business owners and executives, other parties are interested in seeing a good story in the financial statements, including the following:
- Lenders. Applying for a business loan? These financial statements comprise the bulk of a company’s loan application, so make sure they tell a positive story about the business. If they give the wrong impression, the company is unlikely to get a favorable loan package or get any loan at all.
- Investors. Whether an equity or profit participation partner, an investor will scrutinize the documents, looking for a history of growth and a plan for profitability, to ensure strong ROI.
- Business partners. A good numbers story will help potential partners, especially in a merger or sale situation, become comfortable about transacting with the company. How the business is positioned matters greatly.
- High-level employees. In some cases, it may be helpful to get them on board with where the company is heading so their goals and understanding are in alignment with ownership.
All financial statements should be read and understood in combination with one another. Each contributes to telling the full financial story. Make sure the statements tell a good one — or provide information to make the necessary adjustments to write the company’s next chapter.
Steven M. Blankrot
Steven Blankrot, is a manager at CFO Your Way LLC. He can be reached at firstname.lastname@example.org.
This article appeared in the March/April 2020 issue of New Jersey CPA magazine. Read the full issue.