If you’re getting regular monthly financial statements in your business, you’re already ahead of many business owners. But financial reports are only as good as the time you put in to review the information they are giving you.
The two primary financial statements you should be reviewing each month are your Profit & Loss Statement (P&L) and your Balance Sheet. Your P&L tells you how your business performed for the prior month (you can also review the quarter, year, etc.) and your Balance Sheet tells you what you own and what you owe at the end of the month.
Note: It’s important to review your financials on an accrual-basis (vs. cash-basis) to truly understand how your business performed.
When Reviewing Your Financials, Here Are the Top 5 Things to Look For
1. Unknown Accounts
When reviewing your balance sheet, look at each account represented and make sure you understand what the account is for. If you see a bank balance for an account that you closed 3 years ago, check into it. You may have taken a final withdrawal in cash and not recorded it to the books. If you’ve got a loan on your books for a car that you sold last year, something is wrong. It’s possible the interest didn’t get recorded appropriately to get the balance to $0 when the loan was paid off.
2. Negative Balances
Negative balances on either your profit & loss statement or your balance sheet are something you will want to dig into further. A negative balance does not always mean something is inaccurate, but it is something you’ll want to understand better. Typically, a negative balance means that something was recorded to the wrong account, you had to make a correction to an account, or something happened that you wouldn’t want to happen. Occasionally, negative balances are accurate (you wrote a check that overdrew your checking account, for example), but a negative balance is always something you’ll want to review further.
You know your business better than anyone. Even if you aren’t a skilled accountant, you should be able to look at your financial statements and understand if something seems off. If your P&L shows you had revenue of $1,000,000 last month and you’ve never generated that much in a whole year, something’s probably wrong. If your bank balance shows $25,000, but you know you only have $10,000 available, review your bank reconciliation to determine why it’s so far off.
Review your financial statements for trends. Does your profit margin seem to be slipping? Is your cash balance declining each month? Are your expenses fluctuating more than you would expect them to? Reviewing for trends can help you not only better understand your business, but also help you to spot a problem that may be brewing before it’s too late.
Your financials can help you understand the true health of your business. A high-level review of your financials can tell you a lot, but you can gain an even better understanding by using financial ratios. Ratios will help you evaluate your business consistently, whether you’re at $1M in revenue or $100M. While financial ratios may seem to be complicated, the general concepts behind them are relatively simple to understand. And, you can set up templates to help you calculate these each month, so you don’t have to look up the formula every time. Here are a few key ratios to review regularly:
Current Ratio: This tells you how liquid you are. Essentially, can you pay your liabilities with your liquid assets (cash, AR, Inventory, etc.).
Current Ratio = Current Assets/Current Liabilities
- Debt-To-Equity Ratio : This ratio tells you how leveraged you are as a business. How much borrowed money are you using to fund the business?
Debt-To-Equity Ratio = Total Liabilities/Total Equity
- Debt Service Coverage Ratio: This ratio tells you how well you can cover your debt service payments with the income your business is generating. Banks have standard DSCR’s they look for when approving loans.
Debt Service Coverage Ratio = Net Operating Income/Debt Service Payments
By: Shauna Huntington