Financial statements tell a story

Michelle Capone

Even after working with businesses for 15 years, I still find it very interesting when I have the opportunity to review financial statements. A business’s financial statements tell a business’s story without ever speaking with the owner. That is why it is crucial for a business owner to take time preparing and learning how to read financial statements.

There are typically three types of financial statements that a business owner should be familiar with and regularly monitor: the income statement, the balance sheet and the cash flow statement. A business owner should also monitor the aging of accounts payable and accounts receivable at the same time they review their statements.

The income statement, in short, tells the story of whether a business is making or losing money. If revenues are more than expenses, there is an operating profit; if revenues are less than expenses, there is an operating loss.

It sounds simple, but there is a story in both of those scenarios.

Why are revenues less than operating expenses? What direct costs are associated with revenues and are product margins high enough to cover direct expenses? For example, if you sell a pizza for $10 but supplies to make it are $4 and operating expenses, such as utilities, labor and marketing, are $7, you are losing $1 per pizza.

Based on this scenario, the business owner needs to decide whether to raise the retail price, or review product costs and operating expenses to see if it’s possible to save some money. The caution here is to ensure that the customer can afford to pay an adjusted retail price. In a market where everyone else is selling similar pizzas at $15, can you afford to raise your retail price to $20?

While the income statement compiles information over time, the balance sheet provides information on assets, liabilities and equity on a given date. The income statement might tell you if you are making or losing money on operations, but the balance sheet is really the pulse of the business.

At any given moment, the balance sheet shows current assets in cash, inventory and accounts receivable. These are considered current assets because they can be readily liquidated for cash to inject into the business.

It is always wise to review how long you have been holding your inventory or how long it is taking to collect accounts receivable. If you have inventory that you cannot sell or accounts receivable that you cannot collect, you do not have cash coming into the business and may experience cash flow issues. Balance sheets also reflect long-term capital assets like buildings, machinery and equipment.

Opposite the current assets are the current liabilities, which are typically payables like general accounts, sales tax and unemployment insurance. These are the business’s bills. Review the aging of accounts payable when you review your balance sheet. Taking longer to pay bills could have an adverse impact on your credit. Even though it means you have more cash for operations since you are not paying bills, it also means there are issues with cash. Again, there is a story here about whether revenues are sufficient to cover expenses or whether it is taking longer to collect accounts receivable and turn inventory. The answer is typically a combination of the above.

Finally, there is the cash flow statement, which shows how much cash is available to operate your business. If you have receivables, then you know that you may not receive the cash in the same month you complete the work. This means that you have to budget your cash flow in order to pay your bills. A business will often use a line of credit to cover receivables until they are paid. Also remember that the income statement does not reflect any principal payments on debt, only the interest. The cash flow statement allows you to budget for items like principal payments to make sure there is enough cash to pay these expenses.

The information in these statements is only as good as what is put in them. As a business owner, it is very important to take the time to prepare and review financial statements because they do tell quite a story. For technical assistance, contact your Small Business Development Center or an accountant or CPA, or use software like Quickbooks or Peachtree.

Michelle L. Capone is regional development director for the Development Authority of the North Country. Contact her at mcapone@danc.org. She is a member of the Greater Watertown Jaycees and Sunrise Rotary.