Have you ever really "read" your financial statements?

May 13, 2017

Every month you get a full set of financial statements and every month you browse through them then put them in a notebook or maybe just a pile. But do you really read them? What are they saying about you and your ability to lead your company or department forward?

 

Every company has a strategy that is comprised of the choices it has made about what kind of business it is in, what kind of customers it wants to serve, and what makes it different than its competitors. The financial statements also say a lot about the promises the company has made to customers, employees, and stockholders and how well it has fulfilled those commitments.

 

An annual planning document can make a lot of promises that elevate your brand into the stratosphere but as Gary Harpst, business strategist and author says “over time the brand comes to stand for what was delivered – not what was promised.”

 

The financials by themselves don’t tell you a lot. Only when they are compared to something else do they begin to yield their information. The comparisons can be:

  • This year to last year. This is the simplest method of gauging your position.

  • This year to budget. The budget should be a representation of what you expect to happen.

  • This year to standard ratios-general. These are the Current Ratio, Quick Ratio, Days Sales in Inventory, etc. that you read about in school.

  • This year to standard ratios-specific to your industry. You can find these specific ratios in the public library and they are based on your SIC or NAICS code. You can also get these from your industry trade associations as long as you will submit your own information to support the effort.

Trends – have one of the staff create some charts to look at certain items over a period of time (months/quarters/years) and see if it is trending up or down. Pay particular attention to changes you have made to processes and how they were affected. For instance, you hired a collection manager and then you bought collection software to aid them in their work: what was the trend line before and after those decisions?

Structural Analysis – these are about the relationships between various accounts or groups of accounts in your financial statements. Debt to Equity Ratio is a relational measurement as is Return on Investment, etc.

 

Variations on a theme:

In business valuation when reviewing financial statements of a closely held company it is often instructive to keep two sets of statements. The first set is the actual income and expenses and the second set normalizes the statements to weed out those expenses that reflect owner’s salaries and prerogatives.

You would want to substitute owner’s salaries and perks for what you would pay an outsider to run the company. Also, you may be running expenses through the company that are legitimate but not absolutely necessary.

 

When there is a differential and that difference is capitalized over a period of time that becomes the basis for a calculated goodwill. Add the goodwill to the “yard sale” value of the assets and you have the value of the company.

Another investment in managerial ego that could affect the financial statements is to continue to run a department that is not pulling its weight. Using Dynamics SL’s subaccount structure you can get departmental statements via FRX or Management Reporter that would detail where you are making money and where you are not. Let’s say, for instance, that the company made $ 1 million after tax for the current year. Maybe it made $1.4 million in ten departments and lost the remainder in two other departments that were no longer productive. Many companies use the bare bones 6 digit subaccount but there are actually, in some versions of Dynamics SL, 18 characters available. This means you could have financials by Department, Region, Revenue Source, Location, Product Line, and a host of other factors.

Then it is also sometimes helpful to dispense with the stratification of the income statement and merely list the line items from highest to lowest and also have a running total. Once you have hit 80% then draw a line. The expenses above the line are the expenses you should concentrate on and the expenses below the line are less important and do not require nor achieve much benefit from monitoring. The old Pareto Principle or the 80/20 rule has a lot of usage left in it. You know the story: 80% of revenue comes from 20% of customers – they are the ones to cultivate. 80% of old AR comes from 20% of accounts – those are the ones to watch. Focus your efforts on those vital few that really matter.

So, there is wisdom in the CFO’s office and there is gold in the financial statements when you really get down and “read” them. What do your financials say about you?

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May 13, 2017

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