Small Business Financial Reporting Analysis

What is Financial Reporting and Analysis?

When people ask me this question, there are a few metaphors that I could use to describe financial reporting. Sometimes, I will explain financial reports as your company’s report card, while at other times, I will describe it as the roadmap.

I particularly like the roadmap metaphor for financial reports, because it encapsulates the two most important points of financial reports. Financial reports tell you where you have been and where you are headed as a business. They outline the places where your business is spending extra money, how much money the business is worth, and which cash flows are most important.

However, similar to a roadmap, a financial report is only as good as the person reading the report. Many people do not have the accounting skills to properly analyze a financial report and make changes to their business based on the analysis. Many other small business owners are simply intimidated by their financial reports and avoid reading them.

You do not need to fear financial reporting and analysis. With some key definitions and skills in your toolkit, you too will be able to analyze financial reports like a pro and grow your business.

The Benefits of Accurate Financial Reports

An accurate financial report is a thing of beauty. It will clearly outline your company’s position in general and during the period you are examining. Here are a few benefits an accurate financial report can do for you.

Identifying Trends Within Your Business

You might think that you are good at analyzing trends within your business. However, many people struggle to put aside their biases and hopes to look at their business with a clear head. Financial reports are the clear-talking friend that every small business owner needs to help them figure out what is going on.

For example, financial reports can help you identify projects that are costing your business far too much money. Without the clear eyes of financial reporting, your business might keep funding these projects that don’t make smart business sense.

Forecasting and Budgeting

By looking at your company’s past trends, you can forecast a little way into the future. You can examine the past few financial periods to determine which initiatives are continually growing, and which have stalled. This perspective can help you determine which how to adjust your strategy as your business continues to scale.

There are many benefits to having a clear record of your company’s financial performance. For instance, you will be able to determine how much money you should put toward different projects in the future. It allows you to see how much money different projects cost, so you can tell if you are going over or under budget the next time you undertake a similar project.

Accurate Picture of your Small Business

It is very important for you as a business owner to have a strong understanding of your business’s financial standing. Similarly, it is also important for your business to be able to give internal and external stakeholders a summary of your business. Financial reports are able to do both of these things.

A series of clear, strong financial reports is one of your best tools for wooing funders as a small business.

Other Considerations

There are a few more things that every savvy business owner should think about when they analyze their financial reports.

Financial Reporting: Accrual vs. Cash Accounting

There are two popular styles of accounting: accrual and cash. Which style of accounting you choose to use will impact the results in your financial reports. This difference is caused by different timelines for recognizing revenue. Having different timelines impacts how revenue will be reported on your income statement. Those using accrual accounting will count revenue as soon as the sale is made. Alternatively, those who use cash accounting will count revenue when money changes hands.

In most accountants and Virtual CFOs opinion, accrual accounting is preferred. Accrual accounting gives a more accurate reflection of the true revenue and expenses in a period. For instance, if you pay rent in a given month on the 1st and the 31st, cash basis accounting would show that rent expense was double during the month. It would also show no rent expense for the following month. Under accrual accounting, the two expenses would be allocated to the months they were incurred for.

While the reporting of revenue is different, it is important to understand what this doesn’t impact. For instance, the type of reporting does not impact the balance of cash. For small businesses, cash is king. The choice of accounting methods will not impact how much cash the business generates in a given period.

However, different accounting styles will impact the profit and loss statements that you receive for your company. We will talk more about profit and loss below.

What is GAAP?

There are not only different accounting styles that different companies use, but there are also different methods for financial reporting. These methods are based on different accounting principles. GAAP stands for Generally Accepted Accounting Principles, which is the accounting system that the United States uses. Unfortunately, almost nobody else in the world uses GAAP to govern financial reporting. This can make transitioning financial reports from country to country difficult. However, as a small business, that is not your biggest concern.

GAAP specifies how certain transactions should be accounted for. For instance, if you issue stock options or sell a franchise that includes a fee for 10 years of rights. Certain transactions must be interpreted within GAAP.

You may ask, “why do I care?”. That is a legit question. While compliance with GAAP is mostly a good practice, unless you have a reporting requirement to the bank or investors, you can generally use a modified version of GAAP. This allows you to take advantage of GAAP, but skip the parts that might not make sense for your business.

The Big 3 Financial Statements for Small Businesses

As a small business owner, you might not have a big accounting team or CFO to help you analyze financial reports or get a sense of your financial standing. You might be intimidated by financial reporting, and not sure where to start.

Fortunately, most accountants agree that businesses can learn a lot about their business’s finances with just three financial statements. If you learn to correctly read and analyze these statements, you will be well on your way to improving your business.

Income Statement (Profit and Loss Statement / Operating Statement)

The first statement that you need to be able to analyze is your business’s income statement. In simple terms, your business’s income statement tells you what your business earned in a given period of time. The company’s net income is calculated using this equation:

Net Income = (Revenue + Gains) – (Expenses + Losses)

With this statement in hand, you will know what expenses are sapping your company’s finances and which revenue streams are worth widening. Think of it as your company’s medical chart. It shows both the big picture (the net income) as well as smaller details (such as revenue gains from secondary activities).

Balance Sheet

While your income statement focuses on a company’s financial health based on transactions, your balance sheet focuses on your company’s assets and liabilities.

Your balance sheet will help you keep track of all of the things of value that your company owns (assets), as well as the money your company owes (liabilities).

The balance sheet is best for identifying future obligations the company may have and the assets available to meet those obligations. There are several other areas where seasoned financial professionals use the balance sheet to get clues about how the operations of the business are running. For instance, the balance sheet can help answer the following questions:

Is the business carrying enough or too much inventory?
Could their be a spoilage or waste issue with inventory?
What is the cost of capital? Is their an oppurtunity to re-structure their debt?
Are the company’s customers paying timely or is their a collection issue?
Is the company handling accounts payable in a way to maximize cash?
What is the company’s cash burn? How long can they comfortably operate?

Cash Flow Statement

Your business’s cash flow statement is a simple measurement of whether your business is gaining or losing money. It is a measurement of your company’s cash inflows and cash outflows that tells you where you are spending your money in a given period of time. The cash flow statement cuts through all of the accrual, cash, and GAAP adjustments to show the raw cash earnings of the business.

However, it not only tells you how much money your business is gaining or losing, but it also tells you where these gains and losses are coming from. These data are especially essential to small business owners who need to know immediately whether a certain investment is bringing in money or losing money for the company.

Your cash flow statement is simultaneously useful for long-term and short-term planning. This is because it describes your company’s cash flow on both a day-to-day basis and in the longer term.

Armed with your company’s income statement, cash flow statement, and balance sheet, you will be able to make huge strides as a company. These strides include:

Planning future investments
Communicating accurately with stakeholders
Cutting unnecessary costs.

Analyzing Financial Reports

When you begin to analyze your financial reports, there are a few different financial statement analysis techniques that you can use. The analysis techniques that you choose to use will be determined by your goals.

Horizontal Analysis

Horizontal analysis compares current period financial information to the historical information from your company. The purpose is to find trends that might be occurring over the period of time.

For instance, looking at marketing expenses over time gives you an idea of whether your marketing is efficient or might be getting bloated. Further, comparing your marketing expense to revenue over time, shows how efficient your marketing activities may be. Are you getting the same investment on your marketing dollar as you were 6 months ago? Why or why not?

This is great for companies who want to grow but aren’t sure about the best way to go about it. By looking at your company over time, you will see the strategies that are growing more and more successful and capitalize on those.

Ratio Analysis

On the other hand, ratio analysis focuses on analyzing different ratios within a specific report in order. For example, you may look at your cash gap, which is a combination of accounts receivable, accounts payable, and inventory days. This will tell you if you have opportunities to increase your cash balance. This is just one of several financial ratios.

This is a great option for small businesses that are looking to cut costs and streamline. It allows you to see where your company is losing money and where you could be making more money.

How an Accounting Services Pro Can Help Analyze Your Financial Reports

You’re a smart, savvy small business owner, but you don’t have all the time in the world. We get it, financial report analysis can be very difficult. This is why companies like Krieger Analytics have created Virtual CFO and accounting services to help their clients dig through the data of a financial report and find the data gold that can help them. By hiring a professional Virtual CFO or accounting service provider, you can save yourself the trouble and time that learning to analyze financial statements can take. These services can not only help you understand your data, but also use that data to put you on the right track to grow your business. Book a free consultation call with Krieger Analytics today.

Small Business Financial Reporting and Analysis