In another post, I provided a basic explanation of the three essential financial statements. Let’s go a little deeper to see another reason why they are so helpful.
It is interesting to me to observe the causal nature of certain business drivers and how small changes can over time can significantly affect cash and net income. Many business drivers are interconnected through the financial statements. For example, a strategy to improve inventory turnover can have a dramatic positive effect on cash (the balance sheet) and may have a positive or negative effect on profitability (the income statement), and a positive or negative effect on customer service through fill rates and on-time deliveries.
Understanding the basic financial statements is not only helpful for business owners for the obvious reasons, but can also aid in more in-depth scenarios like these, to name a few:
- investors looking at a P&L
- doctors running a medical practice
- sales reps considering customer profitability and gross margin
- accounting staff discussing the de-leveraging the company or evaluating credit worthiness of customers.
Simply put, understanding financial statements can help you ask meaningful questions and make well-informed decisions.
For example, I analyze P&L performance compared to the established business plan and to prior year results. What were the sales and profit drivers vs. expected and compared to historical sales and profit drivers? What were the expense fluctuations vs. expected, and what can be changed to improve results?
Similar for the balance sheet and cash flow statement, I look at the cash flow and liquidity metrics results to compared to expectation. What improvements can be made for improvements for asset velocity and cash flow? How can we maximize effective leverage? See my resources for some basic ratio ideas.
This information leads to small improvements over time which can yield incredible results. For one client, I finished a small project with the goal to improve cash flow and reduce credit risk. We put in a basic credit application process and worked to improve accounts receivable turnover. Over the first four months, a one-person accounts receivable department improved their days sales outstanding average by five days. Over the next year, she reduced accounts receivable turnover another five days. Based on their growing top line with 100% open credit terms, they company had a $150,000+ positive impact to cash as a result of that small project.
Stay informed. Improve your bottom line.
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