Over the years, I have come across loads (too many) business owners who run their business and that’s where it ends. They rarely (if ever) glance at their annual financial statements (AFS). You know what they are – those things you do for SARS, or possibly the bank manager, and come with a fairly large invoice attached.
Just the other day, I glanced at the prospective client’s Income Statement and asked about the fact that they had a reported loss of over a R 100k for the prior financial year. The client was so surprised at this news; they went into mild pain and shock resulted, in fact for a number of days thereafter. She claimed that no one had told her this news, even though the AFS were in her possession for a number of months.
Everyone thinks that AFS are written in some kind of foreign language but by learning some simple principals, the above scenario can be avoided. Even if just to identify differences from the norm, in order to ask your Accountant to explain things in more details.
AFS are another tool in the entrepreneurs’ arsenal in managing or running their business, and they should be used to make more sound financial decisions for the company. The AFS are prepared once a year, hence annual, but they can be broken down into more useful chunks. I recommend a monthly income statement – just one page to summarise they situation on a regular basis.
Accounting is not actually a foreign language but moreover a language that everyone should learn and be about 25% fluent in. 100% fluency in reserved for the more qualified of accountants etc. Accounting (and AFS) is actually simple. If it is complicated – you are doing something amiss. It can get technical but never complicated.
The Financial Statements consist of (and their basic function):
- Statement of Financial Position (old Balance Sheet): (overview of the business at a point in time eg:28 February 20XX)
- Income Statement: (overview of the business for a period eg: monthly, quarterly etc)
- Cash Flow Statement: (An overview of the flow of cash through the business from profits to cash, for a period)
- Change in equity Statement (as it says an overview of the changes in equities in the business)
- Notes to the Financial Statements (these are used for more clarification of certain figures in the above statements. An explanation of them.)
- Directors / owner’s report: Is exactly that – the report that the directors / owner present on the AFS
By focussing on the operational side of the business, by reading the above statements we can determine how efficiently the owner is running their business.
In the Income Statement for instance, the key figure to focus on is Operating (gross) Profit. This is a critical figure in all businesses. If this figure is positive it tells us that the practice is covering all costs, including overheads – a good place to be!
By then comparing this figure to the Cash generated from Operations figure, reflected in the Cash Flow Statement, one can determine how effectively the business is converting profits into cash.
If there is a negative cash flow at this level, the most likely problem is that cash is “stuck” in Working Capital, which we find in the Statement of Financial Position.
In my experience, many businesses encounter cash flow difficulties as a result of inefficient working capital management, with the result, despite the business making profits, there is always a problem with cash flow.
In fact, the financials do not even reflect the working capital figure – one has to calculate this from the information provided. This requires a basic knowledge of what you are reading.
The good news is that you don’t need to wait for your annual financial statements to make the above type of decisions – you can ask your accountant to provide this information on a quarterly basis – this will give you more than enough time to identify issues as they begin to surface, and to implement corrective actions.
A service we provide our clients is a regular analysis of their businesses, with a detailed report identifying the relevant key drivers of their business – these reports allow our clients to be fully aware of their Financial Health of their business, and can quickly respond to request from external stakeholders for feedback on their business.
By using Financial Statements in this way, they become a working tool and an aid in decision making – and this is a great big step in the right direction.
Make AFS a working document, and not something grudgingly done for the authorities.
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