What do Business Success and Understanding your
Financial Statement have in Common?
Many Americans cherish a dream of business success. But, according
to Business Week Magazine, five of every 10 companies fail in
the first five years of business. And the leading cause of failure is
lack of money. How can you avoid becoming one of the statistics?
One of the key contributors to success appears to be the owner's ability
to understand and use his company's financial statements. Making it
in today's business world requires more than looking at the bottom line
on income statements occasionally. It involves understanding and interpreting
what the income statement, balance sheet and some key financial ratios
really mean. It involves using that information to make informed business
decisions. So, if you're not using your financial statements in this
way, how do you get started?
The first step is to acquire a good knowledge of what the reports are
really telling you. The income statement is your best starting point.
Also called a P & L, profit and loss statement or an income and
expense report, it is the summary of events that happened over a period
time. It provides a report of revenue and expenses and is required for
tax purposes. The income statement tells how the business is doing and
how profitable it is. Information from the income statement can be used
to make better-informed decisions about your company's pricing, margin
maintenance and expense control.
The income statement is good for showing you information at a point
in time, but how do you know if your numbers are good or bad? One thing
you can do is look at trends by comparing dollar amounts from year to
year or from month to month. Another option is comparing your results
with others in the same industry. Your best resource is a trade association
for your business. When that is not available, another resource is industry
standard information from Robert Morris Associates, Inc., available
at most libraries, University of Missouri Extension Centers
or Small Business Development Centers.
The second critical source of information is the balance sheet. The
balance sheet shows what the company owns (its assets), what the company
owes (its liabilities) and the bottom line (owner equity). It gives
the financial condition of the company at a point in time. And just
like the income statement, if you really want to see a true picture
of how you are doing, you need to look at trends. You will also benefit
from comparing your statement to companies in your same industry.
However, understanding what information is provided on the income statement
and balance sheet is only part of the equation. To truly be able to
use financial information to make better business decisions, we often
need to look at numbers in relationship to each other. To do that, we
need to look at ratios.
Ratios can tell you about the efficiency of your operation. The key
is to pick out a few important ratios to track and review in your company.
Some good ones to consider are current ratio, which tells you the percentage
of current assets versus current liabilities (this impacts your ability
to pay your bills); days receivable ratio, which tells you the average
number of days customers are taking to pay you; days payable ratio,
which tells you the average number of days you are taking to pay your
suppliers; and inventory turnover ratio, which tells you the number
of times inventory turns over in a year (this tells you how well you
are managing your inventory).
Remember what the statistics tell us—success can be tied to sound
financial knowledge. Begin your road to success by learning to use your
financial statements as the powerful tools they are.
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Authored by: Rayanna Anderson, Asst. Director,
Southwest Missouri State University Small Business Development Center
Source: Creating Quality Newsletter, Volume
12, Number 2, February 2003
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