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A story told through the lens of your financial statements
In every episode of House, ER, and Doogie Howser, M.D., doctors check the charts, review the results, and carefully analyze the patient’s health. The same principle applies to the financial health of your business. CFOs decipher the financial statements to understand the business's economic well-being, which helps business owners determine the next steps.
Keep your finger on the pulse of your business with this high-level guide of balance sheets, income statements, and cash flow statements.
Balance sheet
It starts with your balance sheet, a snapshot of a company's financial position at a specific moment. It provides a quick overview of what a company owns, owes, and the net value it offers its shareholders.
The balance sheet is split into three parts: assets, liabilities, and shareholders's equity, which all contribute to a company’s financial position.
Assets are company-owned resources that have a value, such as:
- Current assets (cash, accounts receivable, inventory)
- Non-current assets (land, equipment)
- Physical assets (machinery, inventory)
- Intangible assets (patents, trademarks)
Liabilities, on the other hand, represent what the company owes. Liabilities encompass financial obligations like loans, mortgages, deferred revenues, and bonds.
Meanwhile, shareholder equity is the total assets minus total liabilities and represents the company’s net worth. Essentially, the better the shareholder equity, the healthier the business.
Income Statement
As the name suggests, the income statement (AKA profit and loss statement or P&L) is a summary of a company’s financial transactions over a specific time (such as a month or a year), providing a linear view of a company’s transactional activities, and how revenue becomes net income.
The bottom line of net income or losses holds significant value for stakeholders, accountants, investors, and business professionals. It is literally the flat-line moment for accounting.
Revenue is at the top of the income statement and represents all income (operating and non-operating) flowing into a business.
These diverse sources of income underscore the multifaceted nature of modern business operations. If your business relies on a single income stream, speak with an experienced CFO about risk mitigation and alternative, non-operating revenue streams.
Expenses are the costs incurred by a company, including the cost of goods sold (COGS), operating expenses, and non-operating expenses. Understanding these fixed and variable costs is vital for strategic financial planning and managing profitability.
Cash flow statement
Watching your bottom line is critical, however, it is equally important to understand your organization's cash utilization, debt, equity, and dividends. This is done via your cash flow statement; a micro-view of your company’s liquidity that tracks cash inflows and outflows from:
- operating activities,
- investing activities, and
- financing activities.
Operating cash flow activities reflect the cash generated by a company’s core business activities, such as sales revenue, accounts receivable, inventory, accounts payable, and operating expenses. Seasonality, sales trends, payment terms, and inflation can all affect cash flow.
Investing activities, on the other hand, involve the buying and selling of long-term assets and investment securities, which can have significant impacts on a company’s financial health. Understanding the nature and implications of these activities can help investors and managers make informed decisions.
Lastly, financing activities reveal net cash flows used to fund the company, involving transactions with debt, equity, and dividends.
Retained earnings statement
The retained earnings statement shows the income accumulated and kept in the company since its inception. It provides an insight into the attitude toward reinvesting in and growing their business versus the cash funneled into dividends. This statement, over time, is invaluable to prospective investors if you are considering a merger or acquisition.
Interlinking financial statements
Like Dr. House's list of medical tests: "CBC, Chem7, and a Lipids-STAT", financial statements should be viewed all together. They are all intricately linked, and understanding these interconnections provides a more comprehensive view of a company’s financial position and performance.
The importance of accounting principles
Mistakes or inconsistencies can lead to unreliable financial statements, stakeholder concerns, taxation issues, and legal problems.
Account principles guarantee financial statements are comparable, reliable, and transparent. Leverage the experience of your accounting team to complete all the checks and balances. Alternatively, reach out to a Kordis team member to help.
Financial health is more than just numbers
Assessing financial health goes beyond reports full of numbers. It requires a thorough examination of:
- Strategy documents
- Projections
- Footnotes
- External factors and practices
An experienced accountant or CFO will look at every facet of your business. More so, a financial advocate will thoroughly explain your company's financial health through easy-to-read reports, such as Kordis Reports.
Summary
Just like your regular fitness checks, assessing a company’s financial health is not a one-time task, but a continual process of analysis and understanding. For more help with your financial checkup, contact a Kordis expert today.