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How to Read and Act on Financial Statements for Business Owners

Eric Weynand, Founder

Financial statements aren’t just some annual or quarterly chore needed to keep your accountants or investors happy. They’re among the most valuable sources of insights about a company that can be the key for leaders looking to:

  • Improve performance
  • Resolve minor problems before they become big ones
  • Grow sustainably with an eye toward the future

But understanding and acting on the information inside them isn’t always easy or straightforward. 

Let’s take a closer look at what you need to know to make the most of these vital documents.

Financial Statements

5 Key Financial Metrics to Monitor for Business Financial Performance

While there are plenty of stats and numbers available on financial statements, business owners can make the most impact by focusing on these five, which provide the most critical data.

1. Net Income

Net income is the simplest and broadest measure of a company’s success. It’s calculated by subtracting all of the company’s expenses from its total revenue. Profitable companies will naturally see positive net income, while those losing money will register net losses.

This is a good starting point for analyzing your business; the rest of these metrics can help explain why this number is where it is.

2. Cash Flow

As experienced business owners know, cash flow and profit or loss aren’t always in sync. This often occurs when there are issues with accounts receivable or accounts payable, like:

  • Difficulty collecting invoices from clients
  • A failure to pay vendors or others on time
  • Carrying a balance on company credit cards

However, cash could also be flowing into investments in the business or even out of the organization as owner’s equity.

3. Revenue

Examining revenue can reveal a wide variety of critical things about a business. This is true not only for top-line numbers but even more so when breaking it down by project, product, customer, and other ways. 

This can provide details on unexpected successes or failures, potential opportunities, and a general sense of how the overall financial picture comes together.

4. Gross profit (Margin dollars, margin %)

By taking overall revenue and subtracting direct costs like the cost of goods sold (COGS), business owners can figure out critical measures of profitability, both as a percentage and in absolute terms. 

This is an especially important metric for growing companies, as it can reveal how scaling up may affect their bottom line.

5. Expenses (operating expenses, OPEX, overhead)

Examine where all of your company’s spending is going on as granular level as possible, breaking down:

  • Administrative costs
  • Sales and marketing
  • Research and development
  • Rent and facilities expenses
  • Salaries and personnel costs
  • And more. 

Each can provide opportunities for more efficient use of cash or critical insights about the nature of operations.

Identify, Measure, and Monitor Operational Metrics that Drive Financial Performance

Businesses looking to operate at their best need to find and track the metrics that make the most significant impact on their overall success. These will vary depending on industry, company size, goals, and other factors. It’s vital to find the most specific and revealing ones that drive performance more than others. 

When it comes to revenue, this can include:

  • The number of units or services sold
  • Total customers
  • Billable hours
  • Sales price per unit
  • And more

From a gross profit perspective, examine the: 

  • Production cost per unit
  • Error or waste rate
  • Overall jobs per day
  • Billable hour percentage

Those focused on improving cash flow should track:

  • Net working capital
  • Days outstanding for accounts receivable
  • The overall approach and process for billing

Finally, the exact nature of expenses is also revealing to monitor, particularly:

  • Ad spending per lead or sale
  • Fixed administrative costs
  • Employee costs (including benefits)
  • And more

Accrual vs. Cash Accounting

Part of ensuring you have the most accurate financial information for decision-making involves keeping records in the right way. This means using accrual accounting instead of cash accounting. The latter method recognizes revenue or expenses when actual cash changes hands, like when an invoice is collected or when a credit card bill is paid. 

However, accrual accounting recognizes these financial events when they occur, for example, when a bill is sent to a client or when an expense is incurred, even if it’s paid later. This can provide a more accurate and stable view of a company’s financial status that removes the influence of cash flow and time to show true performance.

Examples: Accrual Accounting Measuring and Managing True Performance

A good example is a web design firm that signs a six-month contract, with half paid upfront and the balance in two additional payments over the contract. 

Accrual accounting accurately spreads these earnings over six months instead of clumping them into three discrete payments. Doing the latter may result in less stable, harder-to-analyze books, while the former provides an accurate picture of when the work was done. 

The same principle applies to software-as-a-service companies with monthly, quarterly, or annual payment options or a staffing firm that offers a 90-day guarantee for recruiting fee refunds.

Financial Statements

Get the Most Out of Your Financial Statements

Your financial statements are a true treasure trove of insights. By applying these principles, business owners can make dramatic improvements and head off potential problems, all from data they were already generating. 

However, the process can be complex, especially for those new to it. That’s why PlotPath is here to help. Schedule a quick consultation with us and get started on this straightforward path toward business success.