You may think that because you have good bookkeeping and accounting processes in place and your cash flow is under control, you can sit back and relax. Unfortunately, you'd be wrong. This is the perfect time to do an in-depth analysis of where your business stands financially.
A financial analysis should be undertaken on a fairly regular basis – perhaps quarterly - so you know where your business stands to make informed decisions and plans for the future. It’s also necessary if you're looking for investors, for example.
Getting the most out of your financial statements
Your company's financial statements will be your first point of reference for the assessment. These include the income statement, balance sheet, statement of changes in financial position and statement of changes in owners' equity.
You may decide to call a financial expert in to help you with this process, but even so, it's important that you understand the financials and what they reveal about your business. Don't be intimidated by all the information. Just take it one step at a time.
It's a good idea to have your financial recordkeeping done by a professional who knows about the labour and tax laws that need to be complied with. Once you have the statements, you can:
- Identify any negative trends in your operations so you can remedy the situation before it becomes critical
- Keep an eye on your cash flow requirements to identify financing needs early
- Monitor important indicators of financial health (such as liquidity ratios, efficiency ratios, profitability ratios and solvency ratios)
- Look out for increases and decreases in wealth (specifically your or your stockholders' equity)
- Monitor your performance against your financial plan, if you have one
The financial statements that will help you determine the current status of your business are:
- The income statement reveals the money you've make during the accounting period, the costs or expenses that were incurred, the difference between the costs and incomes for the period, or net profit (or loss)
- The balance sheet is a statement of a company's relative wealth or financial position at a given point in time. It shows assets, liabilities and owners' equity
- The position statement, also known as the "statement of changes in financial position" or "sources and uses of cash," helps to explain how a company acquired its money and how it was spent
- The statement of changes in owners' equity is used to bridge the gap between the amount of owners' equity at the beginning of the period and the amount of their equity at the end of the period
Your financial statements are only the foundation for your analysis and they won’t provide all the info you need. For example, if your statements show that outstanding accounts have gone down over the last few years, it either means that you're being more proactive about your debt collection process, or that you are writing off bad debt too soon.
This is why it's important to look further into some of the trends revealed in the statements and find the reasons behind them. If you decide to do a financial analysis of your business, you may decide to use the Financial Fitness Analysis on the Toolkit.
Originally published on the SME Toolkit South Africa website.