Thursday, May 20, 2021

Here Are 5 Financial Reports You Should Be Running

Written by: Mary Ellen Biery
Former Contributor
Sageworks Stats
Contributor Group

Anyone who has ever had or been around a child for several years has experienced that “When did this child get so grown up?” feeling. Days filled with changing diapers, feeding, clothing and carting around children can make it easy to miss the major changes they’re slowly undergoing. Before you know it, you’re looking at a photo and saying, “Wow, that’s no longer a baby/toddler/little boy or girl/adolescent.”

It’s one reason school pictures and well-child checkups are still important rites of passage for many families. They give much-needed perspective on the child’s overall growth and development.

Business owners, too, can be so busy running their “baby” – securing customers for the business, filling orders, hiring and handling day-to-day crises – that major changes can sneak up on them if they’re not careful. Fast-growing companies, for example, can be growing sales at profitable margins, but if customers aren’t paying on time, the firm can run into a cash crunch and fail. “Even though that seems super obvious, I’ve seen really intelligent, great business people fall into that trap,” says Brian Hamilton, chairman and founder of Sageworks, a financial information company.

Here are five key financial reports that can give business owners valuable perspective on the growth and development of their businesses. Owners should run and review these reports periodically – perhaps with their accountant, who can offer advice on improving financials. The first three reports – collectively known as financial statements -- are critical to seeing the big picture of your business, Hamilton notes. “As a business owner, at a basic level you want to know what the cash is going to be in the business, what the profit is, what the revenue’s going to be, can you pay your bills and can you expand, and the only way to do that is to look at your financial statements,” he says.

P&L – The income statement, also known as the profit and loss statement, or P&L, shows revenues generated during a specific period, the costs incurred to generate those revenues and the profits or losses that result. These numbers will influence your marketing efforts, your pricing and your expense management.

Balance Sheet – The balance sheet shows a financial picture of a business as of a specific date. It runs down the assets (what the company owns), its liabilities (what it owes) and the difference between those two, or the company’s equity. Some key line items on the balance sheet include: cash, accounts receivable, inventory, accounts payable and (if you have debt) the portion of long-term debt that is due this year and the balance of any short-term loans (usually secured by accounts receivable and inventory). 

Statement of Cash Flows – This financial statement blends information from both the income statement and the balance sheet to give a picture of how cash is going into and out of a business. For a business owner, the “cash flow from operations” line is one of the most important across all financial statements. It shows over the period listed the net difference of cash that came in and cash that went out on an operating level. “In my experience working with companies in banking and consulting, I find that most business owners typically struggle to get a strong handle on their cash flow,” Hamilton says. “You don’t want to be worrying about paying the next bill. You want to be focused on growing the business.” Looking regularly at cash flow from operations gives better perspective on the health of the business, allowing owners to concentrate on how to improve results.

Net Profit Margin over Time – Tracking net profit margin over several quarters and years can help owners manage pricing, expenses and sales efforts. It shows how many cents in profit are generated by every dollar of sales, and it can vary from season to season and from industry to industry. As a result, it’s most useful to compare a business’s margin to that of industry peers or to itself over several periods. For example, new car dealers have much thinner net profit margins (1.8 percent in 2016 and 1.6 percent in 2017, based on a preliminary estimate from Sageworks) than those of management consultants (12.3 percent in 2016 and 12.4 percent in 2017, based on a preliminary estimate).

AR Days vs. AP DaysAccounts Receivable Days (AR Days) is the number of days until a company gets paid for its goods or services. (The ratio can be calculated by dividing the period-ending balance of accounts receivable by revenue for that period, then multiplying the result by the number of days in the period). Looking at that ratio over several periods can indicate whether receivables are piling up faster than sales or faster than the company’s ability to collect. You can also compare that ratio to Accounts Payable Days (calculated by dividing the period-ending balance of accounts payable by the period’s cost of goods sold, multiplied by the number of days in the period). AP Days indicates how long it’s taking the business to pay suppliers, so like AR Days, it has a major influence on the company’s cash situation. Like other financial ratios, both AR Days and AP Days can vary widely by industry. For example, management consultants’ average AR Days for 2016 was 43.6, while it was 10.4 for new car dealers. As a result, looking at the ratios over time and comparing them to peers is most useful.

At best, running these reports will confirm that everything is running smoothly in your business, just as a well visit to the doctor may confirm that a child's on the right growth trajectory. At worst, compiling the reports will allow you to identify significant challenges before it's too late to turn the business around.

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