Understanding your Financial Statements Part 1 – Introduction
As a business owner, you are probably paying your accountant every year to prepare financial statements. And, if you’re like most small business owners, you may feel that all you’ve come away with is an accounting fee and a tax bill.
But you could be missing a great opportunity. As explained in this series of eight articles, your financial statements are the ultimate story tellers of your business. They tell you where your business is working and where it isn’t, so you can get to work fixing it. And you don’t need an accounting qualification or natural bent for numbers to interpret them.
The role of your financial statements
Developing a successful business depends on having relevant measures to show you what is and isn’t working. These measures can be classified as either leading or lagging.
Lead measures track things that we directly control and that lead to the accomplishment of lag measures, or results. Let’s say you are a consultant and want to increase sales to existing clients. You decide to start proactively asking about their challenges, hoping this will create opportunities for further services. A lead indicator could be the number of clients you contact each week and a lag indicator the increase in average revenue per client.
As lead indicators measure the things you can control, they are generally the most important to focus on day-to-day. However, you also need to know whether your efforts are creating the right results. This is where lag indicators come in.
Financial statements are the ultimate lag indicators. They show the combined financial result of all business activity. And no matter how awesome your business is, if it doesn’t work financially it will not survive.
These articles will teach you how to:
1. Read your financial statements
Your financial statements contain maybe eight or more reports of mind-numbing jargon and numbers. We will cut to the core and focus solely on what you need to know. We focus on the two key reports: The Profit and Loss Statement and the Balance Sheet.
We will explain the only accounting concepts you need to understand to uncover the full story.
2. Calculate and understand your key financial measures
Through a few basic calculations, using figures in your financial statements, you have a full DIY financial health check of your business.
3. Put your results in context
Calculating your financial metrics is one thing, but knowing what those results should be, and how to fix them, is key.
4. Know the limitations of your financial statements
While your financial statements provide the ultimate report card of your business efforts, it is important to understand what they can and cannot tell you.
Your business’s financial health
Ultimately, for a business to thrive, or even survive, it needs to be financially healthy. The purpose of these articles is to help you diagnose your business’s health and understand how to fix it. These articles will help you manage all areas of financial health including:
- Cash flow
- Business finance
The next two articles explain how to read your two key financial statements: The Profit and Loss and the Balance Sheet. I hope you enjoy reading them.