Even if you are a passionate and committed business owner, spending hours delving into the detail of your company’s financial performance may sound terribly unappealing. Yet businesses are made and broken on the decisions that are made. Therefore, how to use the information obtained from your financial statements to make better business decisions begins with understanding of the main three financial reports used.
The three financial reports that are usually used to make a business decision are the Balance Sheet, Income Statement, and Cash Flow statement. It would be very difficult to use financial reports for decision-making if you are not aware of the purpose each serves in operating a business. Obviously, said financial reports MUST be accurate and GAAP (Generally Accepted Accounting Principles) compliant.
The Balance Sheet:
The balance sheet is a summary of the financial balances i.e. assets, liabilities, and equity of a company at any GIVEN time. It depicts a picture of the strength of the company and days of working capital i.e. how easily can a company handle changes in revenue while staying afloat. Balance sheets can also identify other trends, such as how the receivables cycle works, how net profits are being used, and how often equipment is replaced.
The Income Statement:
The Income Statement, also known as Profit and Loss Statement (P&L), reflects the company’s revenue and expenses DURING a particular period of time. The purpose of an income statement is to show how the company has performed, by listing sales and expenses, and the resulting profit or loss.
The Cash Flow Statement:
The Cash Flow Statement simply states the inflows and outflows of cash during a finite period of time. These movements of money will account for the financial products from operation, investment, and financing activities. Although often overlooked, the income statement is an important indicator as being able to internally generate sufficient cash is key to maintaining a healthy business.
By providing a steady and up-to-date financial reporting, a business is able to make appropriate decisions to:
- Reduce costs
- Increase sales
- Raise profitability
- Purchase new capital assets
- Best sources of financing, duration, etc.
Owners and managers can now make informed choices to:
- Allocate human resources
- Continue or discontinue certain activities of the business
- Purchase or rent certain equipment used for the production of goods/services
- And much more
A decision should never be based on information found on one lone financial statement, because one financial report will not provide the complete information needed to make the best decision possible. It would not provide the decision-maker a view of the entire financial condition of its business.
All financial statements are based on historic financial data. Therefore, it is important to understand that any decision made will be based off trends that may never occur in the future. Henceforth, anyone making a decision with the use of financial statements should be aware it is merely guide and business happens in real-time and other economic conditions could cause businesses to miss their mark. A company’s goals, sales or earnings forecasts, and measuring business performance are all things that can be determined with information from financial statements along with an understanding of best business practices and market trends.
In addition to assist you with better decision-making, financial statements are key to:
Investors: Prospective investors use financial statements to perform financial analysis, which is the basis of their decision to invest or not in your business.
Lenders: A lending institution will examine the financial health of your company and use the financial statement to confirm if it has the capacity to service the debt.
Creditors: Vendors who extend credit may use financial statements to assess the credit-worthiness of your business.
Irrespective of the size of your organization, finances are regarded as the life blood of the business. One of the unavoidable responsibilities for the CEO is to ensure the company has sufficient funding. For beginners to intermediate level, Financial Fitness aligns your finances with your business goals. For master’s level, see our Financial Mastery services.
A robust familiarity with your financial statements will always be advantageous. Ultimately, it’s about your readiness to make proactive business decisions on the basis of what really matters most in your specific situation.
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