How to use financial reports to make better business decisions
For some business owners and directors, the thought of spending time reviewing and analysing financial reports is less than appealing. Delving into the nitty-gritty of financial performance can be seen as a chore and is often put off in favour of more engaging business activities, such as marketing, networking and development.
It can be tempting to merely skim financial statements and, provided that the bottom line appears favourable, ignore the details. However, looking more closely at financial reports can provide valuable information which will highlight areas of opportunity and development potential. Looking closely at the detail can also flag areas which require improvement; changes which may be easy to make before any adverse effect on the business.
Here we look at some ways in which financial reports can aid decision making and help to drive business growth and what to look for in the different types of reports.
The balance sheet is perhaps the most fundamental of the financial reports available. Providing a snapshot of the company’s accounts at a given point in time, it is essential for both owners and investors. Balance sheets show how the business uses its money in relation to assets. This type of report also shows what the company owes in terms of liabilities.
The balance sheet shows a business’s liabilities, assets and shareholder equity at a given point in time. It can be used to determine whether there is sufficient working capital and calculate the business’ net worth. The balance sheet can also help a company decide whether future operations are sustainable, and to identify when dividends can be issued.
Reviewing the overall balance, or net assets can, for example, highlight where cash collections are falling behind and mandate increased focus. This review process will help to ensure that there is sufficient cash available to support the operational demands of the business.
P&L (Profit & Loss) Statement
The P&L Statement is commonly reviewed to gain a broad perspective on the performance of the business. It can provide a useful snapshot; however, to obtain a full picture of the finances, it should be used in conjunction with other reporting.
Also known as an Income Statement, the P&L must be correctly compiled to ensure that it provides an accurate summary of the revenues, costs and expenses for the period in question. It should include items such as depreciation and detail when costs or revenue are invoiced, rather than when payments are due or when cash is received.
The P&L Statement is a useful tool for identifying areas of strength and weakness, helping business owners and directors to understand and control goods expenditure and operating expenses. This report can be used strategically to enable focus on more productive areas and plan reductions in areas which are underperforming or failing to meet margin targets.
Cash Flow Statement
The Cash Flow Statement is vital for all businesses but in particular smaller firms. Review of the P&L Statement may indicate that the business is profitable overall. Whereas the cash flow statement will highlight whether there is sufficient cash in the business to maintain day-to-day operations.
Any drop in operating cash highlighted in the Cash Flow Statement should be investigated thoroughly. Reductions may be influenced if the timing of the report has coincided with a large payment run, or funds due to be received shortly after the completion of the report.
This type of financial report may also flag operational issues. Issues include the need to reduce inventory holding, review pricing, check ad hoc expenditure or examine ways to reduce overheads.
For small businesses, in particular, a strong focus on cash flow is critical. This focus helps to ensure that both long and short term liabilities can be met, as well as any future investment for business development.
Financial Reporting to Aid Investment and Lending Decisions
Potential investors or lenders will usually require the above three key financial reports.
From an investor’s standpoint, these reports will help them to make decisions in respect of the overall valuation of the company, its current financial standing and its creditworthiness.
For lenders, an outline of assets, and both short and long term debt, enables evaluation of the risks that may be inherent in lending the business money. It may also influence how much they are prepared to lend and the interest rates charged.
Business owners need to be familiar with all three key financial reports when approaching potential investors or lenders. This will ensure that any questions raised can be answered promptly, accurately and confidently.