Financial Statements: How To Read And Profit From Them
Today, the manager not only knows the batter's average, but his average with two outs and runners in scoring position. He knows how the player bats against right handed and left handed pitching. And, a host of other stats about every player on the opposition as well as his own team.
The same is true in business. Your financial reports provide information about your business that you should be using whenever you make financial decisions. However, the sad fact is, most business owners only look at a financial statement twice a year. They look at the annual Profit and Loss Statement (P&L), (did we make any money?), and their taxes, (how much of our profit do we have to pay?).
Let me show you how different parts of your financial statements can effect your business.
First, what kinds of information are we looking for?
We are going to look at the numbers, ratios and percentages and how each affects your bottom line. In order to know if your numbers, ratios and percentages are favorable or unfavorable you need something to compare them to.
Most associations will have these "base" numbers for your industry and the formulas to calculate them. Your numbers may vary from the average because or your location, city size or company size.
Cost of Goods Sold (Cost of Sales/Cost per customer)
Cost of goods is producing, converting or buying an item that is sold. The formula is very simple: Take total sales of all products and subtract the cost of goods along with "all" overhead and the difference is your gross profit margin. This should be done on an overall basis and again for each product. The individual process will show which products are "winners" and increased inventory might be considered.
Return on sales (How much do you make on each sale)
Another gauge of your business is, how much does it cost for a customer to buy a widget from your business? How much does each sale cost and how much do you make?
You'll need your Profit and Loss Statement (P&L) for this one. Return on sales will show you the percentage you make on each dollar of sales.
The formula: Divide "net" pretax dollar profits by total sales. The beauty of this formula is it measures (in percentage) how efficiently you convert a sales dollar into profit.
Cost-Benefit Analysis: Should you or shouldn't you?
Ever get an idea and wonder if it will work? The cost-benefit analysis will help make that decision. Suppose you have an auto parts store and would like to expand to other cites. If the cost of expansion outweighs the income produced by each store, then the move is not a good idea.
Have you ever had a re-call on a household appliance? Companies often have to weigh the cost of the recall vs. the cost of customer good will, lawsuits and customer confidence. The re-call may cost the company more, in the long run, if they don't do it than if they do.
Could you make more someplace else.
How much do you have invested in your company? How much are you taking out of the business? Salaries, bonuses and benefits can have a major impact on any business.
Start by dividing pretax profits (P&L) by Equity/Net Worth (Balance Sheet). This will show you your return on your investment. If it's less than 5% you could probably make that in a good money market or bond investment. If you like what you are doing...keep doing it. If not, stop working and start living.
How often do you turn-over your inventory?
If you are a retailer or wholesaler you must move inventory. How much tells the health of your business and how well you are managing your inventory. To calculate: divide your "average inventory" into Cost of Goods Sold (P&L). The higher the number, the more turns you have and the healthier your business.
Dealing with accounts receivable
If you are in business you must be paid in a timely manner for your goods and services. Slow pay can put you out of business. You must have a "handle" on how quick the money comes.
The first step is to compute your average sales day. You can take your total sales for the year and divide by 365 "IF" you are open all year. If not compute the number of days you are open for business.
Next, divide that number into your current accounts receivable. This will show you the average number of days it takes for you to collect from your accounts receivables.
Less than thirty days in preferred. 30 to 45 is acceptable; almost anything over 45 days may cause a hardship on your business.
Learn to do it yourself
Accounting is a lot like practicing medicine. The patient comes in, you put on the heart monitor, take blood and other fluids for testing. Then a doctor reads and evaluates the tests and arrives at a diagnosis. The patient is either in trouble or the patient is healthy.
No, I don't want you to do your own accounting. Most businesses need an accountant just to keep them out of trouble with the IRS.
What you should do is learn how to read your financial statements so you know what's going on in your business. Otherwise you will start making decisions creating problems where your accountant is going to have to try to bail you out.