Understanding the Financial Statements
This is the final post for the series on understanding your financial statements. We began with the balance sheet, the income statement, and the statement of cash flows. This week we will discuss how to analyze all three financial statements to get an understanding on how your business is doing financially.
We have talked about each of the financial statements separately however they are all related and paint a powerful picture of how your business is doing financially. 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 cash flows provide information about the cash assets on the balance sheet and are related to the net income shown on the income statement.
By using the information provided on all three financial statements you can determine the financial health of your business. 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. 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 bring collected on the income you receive.
There are two different debt ratios to be considered when analyzing your business’ financial health; 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.
Understanding the financial statements is important in measuring the financial health of your business. I truly hope that the information provided to you in each post has been beneficial to your business. The Countryman Group has set out to make an impact on businesses through sharing bookkeeping knowledge and sharing our experiences.
See you next week as we go over the challenges many law firms have with invoicing.