When assessing a financial statement, small businesses should pay attention to several key items and financial metrics to gain insights into their financial health and performance. These items provide a comprehensive overview of the company's financial position and can help inform important decisions. Here are the key items to focus on:
Revenue represents the total income generated from the sale of goods or services. Analyze revenue trends to understand how sales are growing or declining over time.
Gross Profit Margin:
Calculate the gross profit margin by subtracting the cost of goods sold (COGS) from revenue and dividing the result by revenue. This metric reveals how efficiently a business produces and sells its products or services.
Review operating expenses, such as rent, utilities, wages, and marketing costs, to understand where the company is spending money. Look for opportunities to reduce unnecessary expenses.
Net Income (Profit):
Net income is the bottom line of the income statement, representing the company's profit after all expenses, including taxes, interest, and depreciation, have been deducted. A positive net income indicates profitability.
Earnings Before Interest and Taxes (EBIT):
EBIT measures a company's operating performance before accounting for interest and taxes. It helps assess the core profitability of the business.
Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA):
EBITDA provides a more comprehensive view of a company's operating performance by excluding depreciation and amortization expenses. It's often used to assess a business's cash flow potential.
Cash Flow from Operations:
Analyze the cash flow statement to understand how cash is generated and used in day-to-day operations. Positive cash flow from operations is essential for covering expenses and investments.
Accounts Receivable and Accounts Payable:
Review the aging of accounts receivable to identify overdue payments. Monitor accounts payable to ensure timely payment of bills while optimizing cash flow.
Calculate the current ratio by dividing current assets by current liabilities. This metric assesses a company's short-term liquidity and ability to meet its short-term obligations. A ratio greater than 1 indicates good liquidity.
Examine the company's debt levels, including long-term and short-term debt. Assess whether the debt load is sustainable and if the company is managing its debt effectively.
Inventory turnover measures how quickly a company sells its inventory during a specific period. A high turnover ratio indicates efficient inventory management.
Return on Assets (ROA) and Return on Equity (ROE):
ROA assesses how efficiently a company uses its assets to generate profit. ROE measures the return on shareholders' equity. Both metrics help evaluate overall performance and profitability.
Working capital is the difference between current assets and current liabilities. It shows the company's ability to meet its short-term financial obligations.
Review changes in owner's equity to understand how retained earnings and contributions or withdrawals by owners are affecting the company's financial position.
Key Ratios and Metrics:
Consider industry-specific financial ratios and benchmarks to compare your company's performance with competitors or industry standards.
Notes to Financial Statements:
Pay attention to the notes accompanying the financial statements. They provide additional context and explanations for certain financial items and transactions.
Trends and Comparisons:
Analyze financial statements over multiple periods to identify trends and patterns. Compare your company's financial performance to previous years and industry averages.
Cash Flow Forecast:
Develop a cash flow forecast based on the financial statements to anticipate future cash needs and ensure adequate liquidity.
Assessing these key items in financial statements provides valuable insights into a small business's financial health, profitability, liquidity, and operational efficiency. Regular monitoring and analysis of these metrics are essential for making informed decisions and addressing financial challenges promptly.
Senior Finance Advisor