Financial analysis for dummies

How Financial Statements Can Give Insight on Company's Health

Financial statements are documents that summarize the financial performance and position of a company. They include the balance sheet, the income statement, the cash flow statement, and sometimes other supplementary information. Financial statements can give insight on a company's health by helping you analyze various aspects of its operations, such as liquidity, solvency, profitability, and efficiency. In this blog post, we will explain what each financial statement shows and how to use them to evaluate a company's financial health.

The Balance Sheet

The balance sheet is a statement that shows a company's assets, liabilities, and equity at a specific point in time. Assets are what a company owns or controls that have economic value. Liabilities are what a company owes to others that must be paid in the future. Equity is the difference between assets and liabilities, representing the owners' claim on the company's net worth.

The balance sheet can give insight on a company's financial health by helping you analyze the following:

• How much debt the company has relative to equity: This is measured by the debt-to-equity ratio, which shows how much of the company's financing comes from creditors versus owners. A high debt-to-equity ratio indicates that the company relies heavily on borrowing and may face higher interest costs and default risk.

• How liquid the business is in the short term: This is measured by the current ratio, which shows how well the company can pay its current liabilities with its current assets. A current ratio of at least 1 indicates that the company has enough cash or cash equivalents to meet its short-term obligations.

• What percentage of assets are tangible and what percentage comes from financial transactions: This is measured by comparing non-current assets (such as property, plant, and equipment) with intangible assets (such as goodwill, patents, and trademarks) and financial assets (such as investments and receivables). A higher proportion of tangible assets indicates that the company has more physical resources to generate income. A higher proportion of intangible or financial assets indicates that the company relies more on intellectual property or market conditions to create value.

• How long it takes to receive outstanding payments from customers and repay suppliers: This is measured by calculatingthe average collection period (how many days it takes to collect receivables) and the average payment period (how many days it takes to pay payables). These ratios show how efficiently the company manages its working capital cycle. A shorter collection period means that the company collects cash faster from its sales. A shorter payment period means that the company pays its suppliers sooner.

• How long it takes to sell inventory: This is measured by calculating the inventory turnover ratio (how many times inventory is sold during a period) and the average days in inventory (how many days it takes to sell inventory). These ratios show how effectively the company manages its inventory levels. A higher inventory turnover ratio means that the company sells its products faster. A lower average days in inventory means that the company keeps less inventory on hand.

The Income Statement

The income statement is a statement that shows a company's revenues, expenses, and profits over a period of time, usually a quarter or a year. Revenues are what a company earns from selling goods or services. Expenses are what a company spends to generate revenues, such as cost of goods sold, operating expenses, and interest expenses. Profits are what remains after deducting expenses from revenues, also known as net income or earnings.

The income statement can give insight on a company's financial health by helping you analyze:

• How much revenue is growing over certain accounting periods: This is measured by calculating the revenue growth rate (how much revenue increases or decreases compared to previous periods). A positive revenue growth rate indicates that the company is expanding its sales volume or market share. A negative revenue growth rate indicates that the company is losing customers or facing competition.

• The gross profit margin for goods sold: This is measured by dividing gross profit (revenue minus cost of goods sold) by revenue. It shows how much profit the company makes from each dollar of sales before deducting operating expenses. A higher gross profit margin indicates that the company has lower production costs or higher selling prices than its competitors. A lower gross profit margin indicates that the company has higher production costs or lower selling prices than its competitors.

• The operating profit margin for overall operations: This is measured by dividing operating income (gross profit minus operating expenses) by revenue. It shows how much profit the company makes from each dollar of sales after deducting operating expenses but before paying interest

How can we help

As a business owner, you need to keep track of your company's financial performance and health. You need to know how much money you are making, how much you are spending, how much you owe and how much you own. You also need to know if your business is growing, profitable and sustainable. 

As described, analyzing your financial statements can help you answer important questions about your business, such as:

How profitable is my business?

- How efficient is my business?

- How liquid is my business?

- How solvent is my business?

- How does my business compare to others in my industry?

However, analyzing financial statements can be challenging if you are not familiar with accounting concepts and techniques. You may not know what numbers to look at, what ratios to calculate or what trends to identify. That's where an accountant can help. An accountant is a professional who has the knowledge and skills to prepare, analyze and interpret financial statements. An accountant can help you understand what your financial statements mean and how they relate to each other.

Some specific ways an accountant can help you analyze your financial statements are:

• Preparing accurate and timely financial statements that comply with accounting standards

• Explaining the meaning of each line item on each statement

• Calculating key financial ratios that measure profitability, efficiency, liquidity and solvency

• Comparing your ratios with industry benchmarks or historical data

• Identifying strengths, weaknesses, opportunities and threats in your financial performance

• Providing recommendations for improving your financial position

• Helping you set realistic goals and budgets based on your financial analysis

• Helping you monitor your progress towards achieving those goals

By working with an accountant, you can gain valuable insights into your business's financial situation. You can also make smarter decisions that will help you grow your business.

If you are looking for an accountant who can help you analyze your financial statements, contact us today. We have experienced accountants who can provide customized services for any type of business.