Which Financial Reports Your Business Needs (and How to Actually Use Them)

Knowing what your financial reports mean is very important. Many businesses simply keep track of financial reports because they have to stay compliant, pay taxes or for the sake of bookkeeping requirements. Little do they know the significance of the financial data achieved through proper analysis of business financial statements.

The following text will discuss the essential financial reports for small business owners and how to leverage them to make wiser decisions.

The Importance Of Financial Reporting For Businesses

Financial reporting for businesses is important because of the following:

1. They can help identify reasons for cash shortages
2. They determine the profitability of your business
3. Help in making informed decisions on pricing and capital expenditure
4. Can identify unnecessary expenses
5. Enable clear communication with investors and lenders

The Three Main Business Financial Statements

All businesses should focus on the following three business financial statements, which we will discuss in detail below:  

1. Profit and Loss Statement (P&L)
2. Balance Sheet
3. Cash Flow Statement

Profit And Loss Statement

The Profit and Loss Statement is often referred to as the Income Statement, which shows the total revenue, costs and the resulting profit or loss of the business. The P&L is made for a specific period of time, which could be a month, quarter or year. The main components of the income statement are:

• Revenue or Sales: This is the income generated from the sale of your products or services
• Cost of Goods Sold (COGS): The COGS are the direct costs of producing the products or services that you sold
• Gross Profit: It is calculated as follows: Revenue - COGS
• Operating Expenses: These include expenses such as salaries, wages, rent, utilities, depreciation, bad debts, etc.
• Net Profit: This is the profit remaining, if any, after deducting operating expenses from the gross profit.

How To Read Profit and Loss Statement: There is so much more to the income statement than simply calculating the net profit. Consider the following:

1. Gross Profit Margin: The formula is: Gross Profit ÷ Revenue x 100

If Gross Profit Margin is low, it may mean that your costs of production are high in proportion to your revenue. It could also signal that you are selling at a lower price (since revenue may be low). The Gross Profit Margin can help in making vital decisions on product pricing and in devising strategies to reduce expenses.

• Analyze Revenue: Compare revenue on a month-on-month basis or year-over-year basis. Try to determine if revenue is increasing, decreasing or is stable. This can give valuable insights for decision-makers.
• Understand Your Costs: Go through your operating and finance costs. Break them down into fixed and variable and make strategies to control them from spiraling out of hand. If marketing spend is high, also check the efficiency of these marketing campaigns in generating revenue.
• Net Profit: Compare this with previous periods as well. Changes in revenue and expenses can all affect the net profit.

Balance Sheet Explained

The balance sheet shows the assets, liabilities and equity of the business at a specific point in time. It is also made monthly, quarterly or yearly. It is based on the accounting equation which is:

Assets = Liabilities + Equity

What are Assets? Assets are what the business owns, and is sub-divided into Non-Current (more than a year) and Current Assets (less than a year). These include property, plant, equipment, machinery, inventory, cash, and accounts receivables (money owed by customers).

With information on the cash and accounts receivables amounts, vital data can be extracted. A low or negative cash balance can be a warning sign that the business is struggling to pay off its liabilities. A high accounts receivable can be a reason for low cash, so careful analysis is required as to why customers are paying late. The business may have to push customers for quicker payments or change payment terms to lower credit days.

What are Liabilities? These are the owings of the business and can also be divided into Non-Current and Current liabilities. Examples are accounts payables, bank overdrafts, and loans. If debt is too high, profits can also be affected due to higher interest payments, which can pose a significant liquidity and solvency risk. If debt is low, business owners can consider taking on debt to expand their business and capture any growth opportunities that may come knocking.

What is Equity? Often called the shareholder’s funds, it is the money invested by the owners.

Some important ratios to extract from the balance sheet are:

1. Current Ratio: Current Assets ÷ Current Liabilities. If this ratio is below 1, it may lead to cash flow problems soon.
2. Debt to Equity Ratio: Debt ÷ Equity. Higher debts mean higher risk and higher interest payments.
3. Other important ratios include the Quick Ratio, Trade Receivables Days (days it takes to receive payments from customers), Trade Payable Days (the days it takes to pay off suppliers), and Inventory Days (how many days on average it takes to sell inventory).

Cash Flow Statement Analysis 

The cash flow statement shows where the cash of the business is going. It is also made for a specific period of time. Remember, profit and cash are not the same. A profitable business can still run out of cash because customers are not paying on time, repayments of loans are reducing cash flow and funds are stuck in inventory or other assets.

The Cash Flow Statement consists of three sections:

• Operating Activities: This is the cash generated from your operations. This is a very important indicator of the efficiency of your business operations. A positive operating  cash flow means that your business is generating cash. It is important to differentiate between seasonal trends and normal course of business as well. Slow seasons may typically result in negative cash flow.
• Investing Activities: These are the cash spent on or received from assets. Any purchases or sales of Non-Current assets can be found here. Large capital expenditure can significantly reduce your available funds. Purchases should be timed when the cash position is strong.
• Financing Activities: These include cash received from loans and investors. It also includes any repayments.

Producing all three of these financial reports for small business can generate extremely valuable information on the financial performance and health of the business. Make it a part of your monthly or weekly routine to review business financial statements, and always remember to compare them with previous reports.

Consider Outsourcing Financial Reporting For Businesses

You don’t always need an accountant or to outsource financial reporting for businesses. Start off with your bookkeeping and accounting needs using accounting tools such as QuickBooks or Xero. With these software, financial reports for small business can be generated with accuracy and in real-time using financial dashboards.

However, when business is growing, you may feel time-restricted, unable to keep up with your books. Also, with tax season around the corner or if you need to plan for external financing, you may want to get help from a professional. Experienced professionals can also help interpret financial reports for small business, providing you with key insights into your business’ financial standing.