Understanding the Financial Statements: How to Read and Analyze Your Statements

This is the fourth and final post in a series on understanding your financial statements. I have talked about the balance sheet, the income statement, and the statement of cash flows. Today I will talk about how to analyze all three financial statements together to get an understanding and clear picture of your business finances.

Your financial statements, the balance sheet, the income statement, and the statement of cash flows are all related. By using the information provided on all three financial statements you can determine the financial health of your business. The changes in assets and liabilities on the balance sheet are reflected in the revenues and expenses on the income statement which shows the gains and losses. The statement of cash flows provides information about the cash assets on the balance sheet and are related to the net income shown on the income statement.

How Are Your Financial Statements Linked?

All three financial statements are linked together in different ways.

Net Income

The net income on the income statement is linked to the net income on the statement of cash flows for that specific period. The net income is also linked to the balance sheet however it shows the net income total at the end of a specific date.

For example, if you are looking at your financial statements for the month of March your net income on the income statement and the statement of cash flows reflects your net income for the month whereas the net income on the balance sheet reflects your net income for the year through the end of March.

Ending Cash

On the statement of cash flows the cash at the end of the period is the sum of your operating, investing, and financing activities and is taken from your beginning cash balance from the previous period. The cash balance is also reflected on the current assets of the balance sheet.

Cash

Any balance sheet items affecting cash such as financing and equipment, are reflected on the statement of cash flows.

Analyze Your Financial Statements

Revenue vs. Expenses

On the income statement, you should see a steady increase in revenue and the expenses should be staying the same or grow in-line with the revenue. Compare your revenue and expenses from the previous month to analyze your growth and potential for growth. You can also compare revenue and expenses from the same month last year.

Cash Balances

On the statement of cash flows, you should have a healthy amount of cash in the bank. A low or stagnant balance means your business is not sustainable, therefore your cash balance should show positive long-term growth. On the statement of cash flows and income statement, your cash from operating activities should be consistently greater than the net income. This shows that cash is being collected on the income you receive.

Ratios

There are many different debt ratios to be considered when analyzing your business’ financial health. Two examples are the debt-to-asset ratio and the debt-to-equity ratio. These formulas measure how much your business owes to what it is worth, the lower the number the better. The profitability ratio measures the return on sales and investments. Your annual net profits and annual sales are divided to show your profit margin and is considered healthy if the ratio is high. These are only two but there are many more that could be used to analyze your financial statements.

Benchmarking

Benchmarking is an analysis of your business performance compared to your competitors. The basic areas that are important to compare are revenue, cost of goods/services, net profits, accounts receivables, salary information and data, and financial ratios.

Why is this Important for Your Business?

Understanding the financial statements is important in measuring the financial health of your business. But the most important part is what you do with the information. The financial statement can be used as a decision-making tool within your organization as well as outside the organization. They can be used to help manage costs, increase revenue, forecast cash flow, and build a proper budget for your business. Growth in your business is dependent on taking this analysis information and applying it to improve your business.

Remember your financial statements, the balance sheet, the income statement, and the statement of cash flows are all related, and all this information can determine the financial health of your business. The financial statements are all linked in different areas and there are several different ways to analyze this information. What you learn from this information can be used to grow your business and make the necessary decisions for your success.

If you would like more information on how we can assist you with the analysis of your financial statements, let’s set up a time to talk!

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