Financial reporting doesn’t get a lot of fanfare or attention compared to many other parts of running a business. Still, successful business leaders know it’s a vital part of growth by helping them make smarter, more informed decisions.
Unfortunately, many companies have incomplete data reporting at best, while others don’t even know where to start.
Below we’ll review some key concepts and cover what businesses need to know about setting up financial reporting systems.
The Foundation of Financial Reporting
Before using financial reporting to make better business moves, it’s critical to understand the basics of what you’ll be looking at and how to interpret it.
Understanding Financial Statements
Balance sheets: A balance sheet is used to give a clear picture of the financial condition of a business.
It’s divided into assets, liabilities, and owner’s or investor’s equity.
- Assets can range from inventory and equipment to cash in company accounts or the building the business operates out of.
- Liabilities cover everything the business owes, including accounts payable, loans, customer deposits, or “unearned” revenue, which is money received for services or products not yet delivered.
- What’s remaining when liabilities are subtracted from assets is equity, the value that belongs to owners or investors.
Income statements: The next most important and revealing financial statement for a company is the income statement, which details the profit and loss of an organization over a specific period.
Income statements describe all of the various revenue streams, both operating income, like providing goods or services, and non-operating income, like investments or interest. They also break down the company’s various expenses from the cost of goods sold to salaries and rent or mortgage payments, revealing the net profit (or loss) when these are subtracted from revenue.
Cash flow statements: Cash flow statements also provide critical information about how a business is operating. They break down a defined period of cash flow into three categories: operating, investing, and financing.
- Operating cash flow is whether the company is making or losing money from its primary business activities.
- Investing cash flow covers inflows or outflows from buying or selling assets.
- Financing activities like paying back loans or dividends to investors are also tallied up.
When these numbers are combined, leaders can see the total cash flow and whether the business is making or losing money over a given time.
Key Financial Ratios
Liquidity ratios: Liquidity ratios measure how well a company can cover its short-term obligations based on its current cash or investments that can be quickly liquidated.
The best-known is the current ratio, which divides current assets (cash, accounts receivable, inventory, and more) by current liabilities (accounts payable, short-term loans, or other bills due within a year.) In ideal situations, this number will be greater than one, representing a healthy company that can easily pay its debts in the near term. PlotPath clients see their current ratio on the KPIs file they receive every month.
Alternatives include the Quick Ratio, which doesn’t factor inventory in as an asset, or the Cash Ratio, which only considers cash and cash equivalents compared to current liabilities.
Profitability ratios: Growing profits is the goal for just about any business. Profitability ratios help you monitor your progress on this front.
Profit margin is the key here, determined by dividing profit by revenue. This can be done with either net or gross profits, both of which provide different but equally valuable information.
Businesses can also monitor return on assets, which tracks how net income relates to overall assets, or return on equity, which does the same for owner’s/investor’s equity. All of these ratios are better the higher they are.
Solvency ratios: The flip side of liquidity ratios, solvency ratios take a longer-term view.
An example of this is debt to equity. This shows how much of a company’s financing results from debt that must be paid back.
There’s also the debt service coverage ratio. This divides operating income by the total amount needed to stay current on principal and interest payments. Higher numbers show a company has plenty of flexibility and financial health going forward.
The Benefits of Effective Financial Reporting
Reliable financial reporting results in better data, which means better decision-making. This can have massive effects down the road as it helps to resolve and prevent problems.
Comprehensive financial reporting can also help identify areas for improvement. This allows the business to continually target weak areas and grow overall profits.
These simple actions can do wonders to improve how others view your company’s financial picture, attracting more investors and better terms from lenders.
Strong Financial Reporting Leads to Confidence in Your Business
There are few strategies that can improve a company more than accurate financial reporting.
By considering critical financial statements, ratios, and principles, leaders can easily identify and solve problems that may have gone unnoticed.
While it can be challenging, businesses don’t have to do it alone.
Our team at PlotPath will work with you to build out a financial reporting system for your business. Contact us today to get started!