Most small business owners keep a sharp eye on their bank balance, so why do they need financial statements? If the balance goes up, they are making money, and if it goes down, they are losing money. Isn’t that enough? In reviewing the financial records of small businesses, I learned that many small business owners lack training in the use of basic financial statements like the balance sheet and the profit-and-loss statement, thus they do not appreciate the power of these tools. For many owners, financial statements are generated simply because a lender or the IRS requires them. What many do not know is that these are strategic documents, and they form the foundation of executive decisions in best-in-class small businesses (or any business, for that matter).
Why are financial statements important?
Financial statements provide business owners powerful information that a simple bank account balance never will:
- How much money did I really make? Timing of revenue and costs can confuse managers and cause bad decisions. One of the most important tasks of any bookkeeper or accountant is to properly pair revenues (sales) with cost-of-goods-sold (and other expenses). Is your business is plagued by profitability whipsawing up and down month to month? If so, how could you possibly make effective long-term decisions?
- What products or services cause my business to gain or lose money? Having a big cash balance in checking says nothing about how it got there. Are you making lots of sales at a good margin? Or is your cash balance artificially high because of a loan you have to pay back? Conversely, your business could be losing money by selling unprofitable deals and racking up bills to vendors, but that impact will not appear in you bank balance until it is too late. As a business owner, you need to be able to spot what’s working and what’s not working right away. Financial statements tell you this.
- How should I price my product/services? If your business is quoting its jobs at 18% gross margin, and you spend an additional 20% to pay for the “roof over (the business’) head”, you will see immediately that something’s not right. Either you are paying too much for the “roof”, paying too much to make your product, or not charging enough. Solid financials will help to spell that out.
- What is my break-even? Knowing how much volume you need to sell every month is critical to setting goals. You need to understand your operating expenses and gross margins from the P&L to do this simple analysis.
What Key Performance Indicators (KPI’s) come from financial statements?
You may have heard of other measures of financial performance of your business, “financial ratios” like inventory turns, quick ratio, debt-to-equity, working capital, earnings per share, etc. All are founded in the financial statements of your business, thus any organization using KPIs knows their financial statements are important. Most of the information needed to make the simplest of budgets and forecasts appears in your business’s financials.
How do financial statements detect fraud?
Reviewing financial statements monthly is a critical step to preventing fraud. Without this review, someone could embezzle money and you would not know it until it was far too late. Even if you stood over your employees constantly reminding them that you were watching them, if you’re not looking at your financial statements – and understanding them – you could still be robbed. Your business’s financial statements, when kept correctly, will reliably tell you what you need to know about your operations and their effectiveness. They will also, incidentally, save you and your employees the stress of constant surveillance.
Why should small business owners learn how to read financial statements?
The basics of accounting have remained largely the same since Columbus sailed to the Americas. Why? Not because businesspeople and financiers lack imagination. The original accounting system articulated by Luca Pacioli in 1494 is solid. It is used in every accounting product like QuickBooks because it works. Your business’s financials are the surest, and simplest, means to understanding where money comes in, goes out, and comes to rest.
Whether you know accounting or not, CFOshare’s team of accountants and financial analysts can provide necessary guidance and financial advice to take your business from a bank statement and a confusion of receipts to a thriving enterprise, operating with confident decision-making by using the power of data.