“What gets measured, gets managed.” (Peter Drucker)
Financial reports, such as a balance sheet, income statement, cash flow statement, debtors reports and actual spend vs budget reports, provide an understanding of where your business stands financially at a certain point in time. They detail the business’s financial performance over a period and also raise red flags, reveal opportunities and highlight changes that need to be made to meet business goals in the future.
Especially in trying and uncertain times like these, keeping a finger on the pulse of the organisation’s financial position and regularly reviewing its financial performance provides a range of benefits.
What the right financial reports reveal
- The financial position of the business – past and present – provide invaluable insights for informed decisions about the future, for example, forecasting future cash flow requirements or identifying financing needs timeously.
- Business financial performance can be assessed and analysed with the right reports, for example, evaluating marketing efforts or projecting inventory needs, which allow for improvements to be implemented and tracked.
- Important indicators of financial health – such as liquidity ratios, efficiency ratios, profitability ratios and solvency ratios – can be calculated based on accurate and timeous reports.
- How to better manage costs – costs that are unnecessary, duplicated, over budget, or rapidly increasing are often only managed, reduced or eliminated once categorised and identified in the financial reports.
- Trends – financial reports provide a means to compare financial trends in the business from one reporting period to another, as well as to benchmark company trends against industry trends.
- Where the opportunities are – financial reports reveal opportunities and are essential to review before making big spending decisions or considering ways to grow the business. For example, financial reports may reveal where outsourcing or automation are viable options, or where changes to employment structures, operating systems or processes are required; or where there are opportunities to grow and expand into new locations or product lines.
- Tax liabilities, challenges and deductions – reviewing financial reports can help manage ongoing tax liabilities, flag potential tax challenges, and reveal possible tax deductions.
- Financial irregularities or risks – regularly reviewing financial reports ensures that potential areas of concern regarding irregularities, risks or even fraud are picked up timeously and can be quickly addressed.
- Viability for third parties – financial institutions, creditors and potential investors will request financial reports to consider credit lines, loans or investments in the company.
The 5 financial reports to understand
To enjoy these business benefits, there are five financial reports to understand – and review regularly – at least on a quarterly basis, but ideally on a monthly basis. This will provide a finger on the business’s financial pulse and enable more accurate and relevant business decisions.
1. Profit and loss (P&L) statement
The profit and loss statement, also called an income statement, summarises the profit or loss over a certain period by reporting on three components:
- total income (or the total sales less costs of goods sold);
- total expenses including operating costs, taxes, utilities, insurance and interest on loans; and
- net profit or loss, calculated as total income less total expenses.
This report reveals whether the business made a profit or a loss during the specific period, and also allows the calculation of profit margins, operating profit margins and operating ratios. This allows profitability to be evaluated and enables investors or creditors to assess the level of risk in the business.
To be profitable, the income in the business should exceed the expenses. However, companies may show a net loss at times, and the reason should be evident in the reports, for example, slow business periods or times when extraordinary expenses are covered. Where the net profit is continuously lower over more than one period or expenses regularly exceed income, these may be red flags of financial trouble.
2. Balance sheet
A balance sheet provides a summary of the company’s financial position at a specific point in time by summarising total assets and total liabilities, as well as shareholders’ equity, or investments and retained earnings.
The assets, or what the business owns, can include cash and investments, equipment and property, stock and accounts receivable. Liabilities, or what the business owes, include loans, accounts payable, wages, rent, taxes and utilities.
It is used to calculate factors such as the current ratio of assets to liabilities, a measure of a company’s liquidity or ability to pay short-term liabilities. This is a particularly crucial consideration when borrowing money from a financial institution or requesting credit from a supplier. A declining current ratio could also indicate financial problems.
3. Cash flow statement
A steady cash flow is one of the most crucial success factors for business, especially smaller business, and this makes regularly reviewing the business’s cash flow statement vitally important.
Summarising the expected cash inflows and outflows over a period, the purpose of this statement is to reveal which areas of the business are generating and using the most cash; enable informed budgeting and spending decisions; as well as to allow potential cash flow problems to be identified and managed in time.
A cash flow statement will also show how readily a company can meet its debt and interest payments; and how much money was distributed to owners or investors as dividends.
4. Debtors’ reports
Cash flow problems are often a result of poor management of debtors. An aged debtor’s report enables current and overdue invoices to be tracked and proactively managed to ensure payment is received on time. Lenders and investors will also look at this report to better understand a company’s creditworthiness.
5. Budget vs actual income and expense reports
Comparing actual revenue/sales against the budgeted figures for a period indicates how well or otherwise the business is trading.
These reports allow a comparison of actual spending as recorded primarily in the income statement, against the amounts budgeted for the period, to assess how well spending matches financial forecasting projections and where there are areas that are over or under budget.
The percentage of costs of goods sold to sales for a period indicates how sales pricing and control over the costs of goods sold are being managed.
Speak to your accountant about accessing these reports on a regular basis and for professional assistance in understanding what the reports reveal about your business. Regularly reviewing your company’s financial reports will unlock many business benefits, provide a finger on the financial pulse of your business and enable more accurate and relevant business decisions.
Disclaimer: The information provided herein should not be used or relied on as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your professional adviser for specific and detailed advice.