Using Your Financial Statements to Tell You a Story

Your financial statements tell you a story – how to read them for education and empowerment.

Most people view financial statements as numbers on a page, very complex, hard to understand, “too much information that doesn’t have much to do with our business.” To the untrained, this is understandable. But, your CPA or controller should help you understand your financials and assist you in understanding the story that your financial statements tell.

First, financial statements are organized into four (4) parts.

Balance sheet – your statement of financial condition. Much to tell, it summarizes
1. Solvency – do you have enough assets to pay your debts? Assets – liabilities = cushion to protect the company.
2. Liquidity – can you pay your bills when they come due? Current assets – current liabilities – working capital cushion to cover cash needs.
3. Trends over time – last year to this year – did it get better?
4. Benchmark to your peers – compared to others and competitors – are you stronger on weaker?
Income statement – your performance report
1. Ends with profits for this period – did all of our effort add back money to the business that justifies the effort spent by everyone.
  1. Trends over time – improving from previous periods?
  2. Use of Capital – ROE – did the company perform better than putting the capital to use in a safe investment. Profits/Equity – yield created by the company – compare to other choices.
  3. Use of assets – return on assets (Profit/Total assets). A test to see if you are using your assets well. Low ROA means we own too many assets. Consider selling what we don’t need or leasing instead of owning.
2. Starts with revenue
  1. Are we improving? Or declining?
  2. Does our strategy for the future address this
    1. How to increase sales
    2. How to protect sales we have
    3. Can we add new products and add incremental revenue
    4. Do we understand our product mix? Customer mix? Strength or weaknesses in either
3. Then look at cost of sales and gross profit
  1. Rising in proportion to sales or faster?
  2. Cost of buying our products or materials rising faster than our ability to pass on costs?
  3. Is our gross profit % going up or down? Sales – cost = gross profit
  4. This is the margin left after the sale to take care of everything else. Very important number.
4. Operating expenses – administrative costs, office costs, selling and marketing costs what we do to support our sales.
  1. Up as an amount? Up as a %? Are we letting everyday expenses take too much away?
  2. Subtle challenge – easy to lose costs here?
  3. Are we repricing when we can?
5. Other expenses – interest expense or earned. Are we borrowing effectively, rate? Terms – short vs. long term. Note operating activities shown her. Single, not recurring transactions, one off? Gain or loss of assets sold in years?
Cash Flow statement – Cash is the blood in the body of the company. Section divided into three.
1. Cash produced (or used) by normal operations.
2. Cash provided by investment activities – did we purchase or sell property and equipment?
3. Cash provided or used by financing activities – Did we add to debt or pay it down, using cash? Did we issue stock for cash or pay dividends?
4. Tells us what else we did in the business to add to or reduce our cash assets in the business.
Footnotes
1. 1^st purpose is to explain methods and assumptions in the numbers.
2. 2^nd purpose is to disclose required activities to the reader to explain things that might not be clear.
3. 3^rd purpose is to add detailed information and analysis of major assets, liabilities or operation activity that changed or impacted the business in the year.
Finish the story — Financial analysis uses pictures (graphs) and ratios to add to the story.