1. Three viewpoints on a company's financial performance are provided by the balance sheet, income statement, and cash flow statement.

What assets does your business own and what debts does it have to others? What are its revenue sources and how has it used its funds? How much money did it make? How is the company's financial situation? The balance sheet, the income statement, and the cash flow statement are the only three financial statements that may be used to provide an answer to these questions.

Balance Sheet

An organization's assets, liabilities, and book value, also known as owners' equity or shareholders' equity, are all listed on the balance sheet.All of a company's available physical resources that it can use to further its business are referred to as assets. A liability is a debt owed to a supplier or another creditor.

Assets = Liabilities + Owners’ Equity or Assets - Liabilities = Owners’ Equity

On one side of the ledger, the balance sheet displays assets, and on the other, liabilities and owners' equity. Because the two sides must always balance, it is known as a balance sheet.

Marketable securities, cash on hand, receivables, and inventories are examples of assets. Liabilities are sums of money that must normally be paid off within a year and are owed to creditors and others.

How you relate to the balance sheet.

Accountants make balance sheets, and the information they contain is important for managers who don't work in finance.

Financial leverage

Financial leverage is the use of borrowed money to buy an asset. People say that a company is highly leveraged when it has a lot of debt on its balance sheet compared to the amount of money its owners have put into it. Operating leverage, on the other hand, is a measure of how much a company's operating costs are fixed instead of changing.

If the value of an asset goes down or if it doesn't bring in as much money as expected, the leverage works against the owner of the asset.

Working Capital

When you subtract the company's current liabilities from its current assets, you get its net working capital, or the amount of money it needs to run its current business.

A company can be in a bad position if it doesn't have enough working capital: It might not be able to pay its bills or take advantage of money-making chances.

Income Statement

The income statement/profit and loss report shows how well a business did over a certain amount of time, like a quarter or a year. It tells you if the company is making money or losing money, or if it has a positive or negative net income, and how much.

A simple equation can be used to show what the income statement is:

Net Income= Revenues – Expenses

Why should you care about the income statement?

Generating in money

If sales at the same store or for the same product go up faster than those of the competition, it's likely that the people in charge of sales and marketing are doing a good job. It's important for managers in these departments to know how to read an income statement so they can figure out how to balance costs and income. If, for example, sales reps offer too many discounts, they could cut into the company's gross profit.

If marketers spend too much money trying to get new customers, it will cut into their operating profit.

Cashflow Statement

The cash flow statement is the one that is used the least and is the hardest to understand. It shows in broad categories how a business made and spent money over a certain time period. As you might expect, expenses show up on the statement as negative numbers, while income sources show up as positive numbers. In each category, the bottom line is just the net amount of money coming in and going out. This number can be positive or negative.

Have you heard? How much money did a business make? What is its financial health like? You can find the answers to these questions by looking at the balance sheet, the income statement, and the cash flow statement.

2. Ratio analysis lets you look more closely at the information in the three financial statements.

Financial statements tell you a lot about a company, like how much money it made, where it spent its money, and how much it owes. But how do you figure out what all of these numbers mean? For example, how much money does the company make? Is the amount of debt good or bad? With ratio analysis, you can get a deeper look at the information in the three financial statements.

Using ratios, you can compare how well your company is doing to the averages for its industry and to how well it did in the past.

Ratios of Profitability

These numbers show how profitable a company is by putting its profits as a percentage of other numbers.

Earnings from assets (ROA). ROA shows how well a company is making money by using its assets. It's a good way to compare the size of different companies.

Return on investment (ROE). ROE shows the profit as a percentage of the stockholders' equity. In a sense, it is the owners' return on their investment, and you can bet that shareholders will compare it to what they could earn with other investments.

Return on sales (ROS). ROS, which is also called net profit margin, shows how well a company controls its costs and turns its income into bottom-line profit.

Gross margin of profit. Taking only direct costs into account, the gross profit margin shows how well a company makes its goods or provides its services.

Profitability ratios will tell you if your company's profits are strong or weak.

Operating Ratio

This shows how well a company is putting its assets to work and handling its cash.

Asset turnover. This ratio shows how well a company makes money with all of its assets, like cash, equipment, and so on. It gives the answer to the question, "How much money do we make for each dollar of assets?"

Receivable days. This number, which is also called days sales outstanding (DSO), shows how quickly a business gets the money it is owed by customers.

Days payable. This number, which is also known as days payable outstanding (DPO), shows how fast a company pays its suppliers. If everything else stays the same, the longer it takes, the more cash a company has to work with.

Operating ratios help you figure out how efficient a company is.

Liquidity Ratios

Liquidity ratios show how well a company can meet its short-term financial obligations, like paying off debt, making payroll, and paying its bills.

Ratio right now. This ratio compares the current assets and current liabilities of a company. To figure it out, divide the total amount of current assets by the total amount of current debts.

Short answer. This ratio isn't easier to figure out than any other, but it does show how quickly a company can meet its current obligations.

Debt Ratio

Coverage of interest. This ratio measures how safe a company's debt is, or how much profit it makes compared to how much it pays in interest over a certain time period.

From debt to stock. This measure shows how much a company borrows money to improve its return on owners' equity.

When you compare a company's ratios to those of its competitors and to the averages for its industry, you can often see what its financial strengths and weaknesses are. For example, if your company's debt-to-equity ratio is higher than average, it may be more likely to be hurt by a downturn in the industry.

Have you heard? You can tell if a company will be able to pay its bills by looking at its current and quick ratios. If it can't do that easily, it may cut costs quickly. It might even need to change how it runs.

3. Profit, as indicated on the income statement, is different from net cash, as indicated on the cash flow statement.

Why is this the case?

There are three crucial justifications:

Sales are when revenue is booked.

Every time a business delivers a good or service, a sale is recorded. Delivering brochures to a customer for $1,500 results in Ace Printing Company recording revenue of $1,500; theoretically, Ace Printing Company may earn a profit based on deducting costs and expenses from that revenue. However, no money has been exchanged because Ace's customers normally have at least 30 days to pay. Profit always reflects the commitments made by clients to pay as it all begins with revenue. Contrarily, cash flow always represents monetary transactions.

Revenue generates profit, whereas cash flow always reflects cash transactions.

Revenue and expenses are matched.

The income statement's goal is to total up all the expenditures and expenses related to producing revenue during a specific time period. Those costs, however, could not be the ones that were really covered at that time. Some may have received payment sooner. Some of it will be paid once the vendors' invoices are due. As a result, the income statement's expenses do not accurately reflect cash outflow. However, the cash flow statement always tracks the amount of money coming in and going out during a specific time period.

Capital costs are not deducted from profits.

When a capital expenditure is made, only the depreciation is charged against revenue; the capital expenditure does not appear on the income statement. Therefore, a business can purchase computers, trucks, machinery, and other items with the knowledge that the expense won't be recorded in full until each item has reached the end of its useful life. Of course, money is another matter: All of those things are frequently paid for before they have fully depreciated, and the cash that was needed to do so will be shown in the cash flow statement.

The gap between profit and cash can cause all kinds of trouble in the interim, especially for a growing business.

The fact that one significant client pays its bills very slowly or that one significant vendor needs upfront payment may be something they will have to deal with. Even while none of these significantly effect profitability, they can all have a disastrous impact on an entrepreneur's cash flow.

You should comprehend the cash flow statement for three main reasons. The first benefit is that it will assist you in understanding the current situation, the direction the company is taking, and the probable priorities of top management.

You also have an impact on money. Instead than concentrating on both profit and cash, most managers place their attention solely on profit. Of fact, they often just have an impact on operating cash flow, but that is still one of the most crucial metrics available.

Third, as opposed to managers who solely concentrate on the income statement, those who have a solid understanding of cash flow are more likely to be given greater responsibilities and, consequently, to grow more quickly. You may approach someone in finance and say, "I notice our DSO [days sales outstanding] has been headed in the wrong direction over the last few months; how can I help turn that around?" Alternately, you may study the principles of lean enterprise, which emphasizes (among other things) keeping inventories to a minimum. Huge sums of money are liberated when a manager guides a business toward being lean.

When possible, do you postpone paying bills? When buying something, do you take cash flow into account? This is not to argue that delaying spending is always a good idea, but rather that it is a good idea to consider the cash impact of your decision before making it.

Don't limit yourself to cash flow. Consider other aspects of your business as well, such as how satisfied your customers are with your service, how well-connected they are to your salespeople, and how accurate your invoices are. These aspects all contribute to how customers perceive your company and, in turn, indirectly affect how quickly they will pay their bills. Customers that are dissatisfied are not known for paying quickly; instead, they prefer to wait until any disagreement is settled.

Unaware of this? Together with profitability and shareholder equity, cash flow is a crucial sign of a business's financial stability. It completes the triad's chain.

4. A company needs more working capital to operate the business the longer its Day Sale Outstanding is.

Most businesses fund client purchases of goods and services using cash on hand. The amount of money customers owe at a specific period, based on the value of what they have purchased prior to that date, is represented by the "accounts receivable" line on the balance sheet. Days Sales Outstanding, or DSO, which represents the typical time it takes to collect on these receivables, is the fundamental statistic that gauges accounts receivable. A company needs more working capital to operate the business the longer its DSO is.

The DSO is the typical time it takes to collect receivables.

How to control DSO?

Managers in charge of operations and research and development, for instance, should consider whether there are any issues with the products that can discourage customers from making payments. Does the business offer what clients want and anticipate? Is the delivery problematic? Because clients are dissatisfied with the products they are receiving and opt to take their time with payment, quality issues and delayed deliveries frequently result in late payment.

Managers who interact with customers, such as those in sales and customer service, must pose a comparable set of inquiries. Are our customers in good financial standing? What is the norm for paying invoices in their sector? Are they located in a country or region that pays promptly or slowly? It is up to salespeople to raise any concerns about a customer's financial situation since they sometimes have the first interaction with a consumer.

Credit managers must determine whether the terms being offered are advantageous to the business and appropriate given the consumers' credit histories. They must assess if the business extends credit too readily or is overly stringent in its credit standards. Increasing sales and giving credit to people who pose a higher risk of default are always trade-offs. Credit managers must specify the exact conditions they are willing to accept. Is net 30 days acceptable, or must we to allow net 60?

Credit managers need to come up with measures to stop late payments, such providing discounts for early payment.

What inventory management is?

These days, inventory is a key concern for many managers (and consultants!). Anywhere they can, they try to lower it. They employ trendy terms like "just-in-time inventory management," "lean manufacturing," and "economic order quantity" (EOQ).

The trick is to keep as little inventory as possible while still making sure that every component, including raw materials, will be available when needed and that every product will be offered for sale when a consumer requests it. A manufacturer must constantly place orders for raw materials, produce goods, and store them for customer delivery.

In order to avoid the dreaded stockout, which is when a product is unavailable just as a client needs it, wholesalers and retailers must continually replace their stock. But, every item in inventory can be thought of as frozen currency, or money that the business is unable to use for other purposes. How much inventory is actually needed to keep up with demand while reducing that frozen cash? That is, after all, the million-dollar query (and the reason why companies engage consultants).

Did you realize?

The less inventory a corporation needs to carry, the more salespeople may offer standard products with few variants. When a product line is kept simple with only a few easily replaceable options, inventory goes down and keeping track of it is easier.

5. Tools for accounting and finance that provide solutions to some of the most crucial management issues

The fields of finance and accounting offer a wealth of useful tools that can assist in addressing some of the most significant management issues you'll ever encounter:

Cost-benefit Analysis

It's critical to comprehend the price of the status quo. You should compare the relative benefits of each investment with the potential drawbacks of doing nothing at all.

The following steps are included in cost/benefit analysis:

  • Determine the price of the new business opportunity.
  • List the advantages of the extra income the investment will generate.
  • Determine the cost savings that can be achieved.
  • Create a timeframe for the anticipated costs and revenues.
  • Assess the costs and non-monetary advantages.

Then, using one or more of the analytical tools listed below, such as accounting return on investment, payback period, or breakeven analysis, you can start assessing the investment potential.

Return on investment in accounting.

Commonly known as Return on investment (ROI), this indicator is not always the most accurate. Nonetheless, because so many managers still utilize ROI, it is vital to comprehend their perspective. Cost reductions, additional profit, or value growth are all examples of accounting return on investment. Let's examine the most straightforward method of calculation, which isn't particularly realistic. By simply deducting the total cost of the investment from the total benefits gained, you would start by calculating the net return. The return would then be divided by the entire cost of the investment to determine the ROI.

Payback interval.

Businesses often want to know how long it will take an investment to pay for itself, or the payback period.

The payback period is only useful as an analytical tool to determine how long it will take you to recover your investment.

Breakeven Point Analysis

Breakeven analysis identifies the amount (or amount more) that must be sold in order to cover the fixed investment, or the point at which your cash flow will become profitable. With that knowledge, you may assess whether it's reasonable to anticipate selling that much by examining market demand and market shares of competitors. You can consider the effects of altering the links between price and volume by using breakeven analysis.

The majority of businesses base their breakeven analyses on sales and gross profit margin. You must comprehend the factors that go into the calculation before you can conduct it:

• Fixed expenses. No matter how many units of a good or service are sold, these expenditures, such insurance, managerial salaries, and rent or lease payments, largely remain constant.

• Variable expenses Costs that vary according to the quantity of goods produced and sold are known as variable costs.

• Margin of contribution. This is the amount that each sold unit goes toward covering fixed costs.

With an understanding of these ideas, we can use this simple equation to perform the computation.

Breakeven Volume = Fixed Costs / Unit Contribution Margin.

Once you've made the decision to pursue an investment opportunity, you should keep track of its development. Compare your forecasts to real income and spending. Doing this once a month will help you identify any possible issues as they arise.

Did you realize? No matter how many units of a good or service are sold, fixed costs, including as insurance, management salaries, and rent or lease payments, largely remain constant.

What financial statements won't tell you

Essentially, the financial statements reflect the past. The income statement and cash flow statement provide information on how a firm performed in a previous time period along specific dimensions. You can see a snapshot of its financial situation on the balance sheet as of a particular date. Business, however, also needs to be aware of what is happening right now and what is expected to occur tomorrow.

These are three important informational categories that are not covered in the financials.

1. The non-financial health of the company.

Regardless of what the financials may indicate about the fiscal health of a firm, if it has safety difficulties, it is probably an unhealthy organization and is likely to encounter one crisis after another. One facet of organizational health is safety (and one that is far more relevant in mining or manufacturing than, say, in banking). The amount of employee involvement is another. Does everyone who works there enjoy it? Would they suggest it to a pal? You need information from employee surveys and indicators related to human resources, such as staff retention rates, to be able to respond to these questions. None of this information can be found in the financials.

The financials have no specific data regarding organizational decisiveness. Via staff surveys, interviews, and internal focus groups, many businesses collect information about it. The findings assist management in understanding why and how the company's future financial performance can suffer, similar to how employee engagement is affected.

2. What consumers are contemplating.

However, customer attitudes—their pleasure with a business and its products, their complaints and gripes, their intention to make another purchase, and so on—do not show up on the financials. Nonetheless, those behaviors are important predictors of a business's future success. After all, a company's future are likely to be bleak if it can't retain its current consumers and draw in new ones.

There are various different types of research needed to determine customer attitudes. A good place to start is with the regular customer satisfaction surveys that the majority of large organizations carry out. (Yet, the accuracy of this statistics is frequently questioned.

3. What rivals are preparing?

Every company is susceptible to rivals, thus it is in your best interest to learn as much as you can about your competition.

The majority of businesses spend a significant amount of time and money attempting to predict the next moves of rivals, thus this point is hardly novel.

The reports and press releases of their rivals, conversations with educated analysts and observers, and attendance at industry conferences are all ways that shrewd businesses keep a close eye on such plans. Businesses that ignore their rivals do so at their own cost.

Every manager should study the financials, comprehend them, and keep up with them. This includes not only the three main statements, which are summaries, but also daily information on revenue, operational costs, performance compared to budget, and other related topics. But, if you put too much faith in the figures and neglect to take into account variables they don't account for, you could find yourself in danger.

6. Summary

The amount of working capital, which normally increases and decreases with the level of sales, is something that financial managers pay close attention to. A corporation that has insufficient working capital may find itself in a difficult situation where it is unable to pay its debts or seize valuable possibilities. Yet, excessive working capital lowers profitability because it must be financed in some way, typically through interest-bearing loans.

Many people who use financial statements to learn more about businesses have noticed that the traditional balance sheet is unable to accurately reflect the value and potential profitability of intangible assets like human capital and goodwill (the figure only includes intangibles that were owned by the acquiree at the time of the acquisition). The fact that intangibles aren't on the balance sheet is especially important for knowledge-intensive businesses, whose most valuable assets may be their knowledge, intellectual property, brand value, and connections with clients. In order to figure out how much a company is really worth, managers and investors need to look beyond the physical assets listed on the balance sheet, such as buildings, machinery, and cash.

Companies seeking to increase return on invested capital (ROIC) should use supply chain economics to respond to three crucial customer-related concerns.

  1. How do we sell things? Is it possible to simplify stock-keeping units (SKUs) and get rid of complexity, expenses, and assets?
  2. Who do we sell to, second? Do we have the appropriate market focus? Are our supply chain management strategies focused on areas where the business may profit from them? There may be some sectors that are relatively unproductive when profitability is broken down by client, region, and channel.
  3. How can we deliver our offerings in the best way? Are our service policies and infrastructure performing their tasks effectively?

Customer segmentation should be a top priority for supply chain leaders. Knowing what customers desire can help us determine which items will best meet their needs. Then, supply chain managers can set various service standards for various clients and goods.