Financial Statements should be More than a Stack of Papers in a Drawer

By Joe Day, CPA

Image courtesy of flickr

I see this all too many times in my accounting business.  Many times, the CEO of a small business will glance at a financial statement I’ve sent, only to open the file drawer and put it in the folder with the last three quarters.  Never taking the time to consider the implications those financial statements provide is a missed opportunity.  Why?   “If you ignore the past, how can you focus on the future?”  A valid perspective of where your business has been and where it is now, is vital if you want to know where it is going.  More importantly, the answers to these questions can be had at a glance by looking at balance sheet.  Do you see a buildup in receivables? Need to look at the Aging Schedule?  Is Inventory sufficient for the next operating period?  Do you have the financial strength to borrow what you need to acquire inventory and equipment that will enable you to manage the growth you’re looking forward to?

Are You Leveraged to the Hilt?

If you’ve borrowed a significant amount of money, you are usually required to provide the lender with a copy of the periodic financial statement (Quarterly as a minimum; monthly when the amount requires monitoring by a loan officer).  You should know what information the financier is looking at.  There are standard factors that all financiers look at:  Quick Ratio, Current Ratio, Debt/Equity, Asset Turnover, Aging of Receivables.  Then there are more sophisticated demands such as rolling 12-month comparative statements; Same Month Last Year; Year-to-Date to Same Period Last Year; etc. Then there are specific Metrex stated in the loan covenants.  All this information is used to determine the health and future expectations for your business (and, whether you’ve become a poor lending choice or not). 

Covenants in loan agreements many times spell out certain key performance indicators that your business must meet to allow the lender to keep the loan in “Good Standing”.  Violation of a covenant (performing below the required level stated in the loan agreement) can result in the loan being called and immediate repayment required which can be a disaster.  You are expected to know whether you’re performing at the standard set.  You are expected to know what your financial statement is telling the financier.  When they call to ask you about the financial statement, the phrase they don’t want to hear is: “I haven’t looked at my financial statements.  Let me get it out of the drawer so I can see what you’re talking about.” 

Do You Know Your Assets form a Hole in the Ground?

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When you want to know how you’ve done, you need to know how to read the balance sheet.  If the balance sheet is not representative of the facts at the end of the period under consideration, the income statement is not likely to represent the true worth of the business. 

Very few negative numbers should show up on a balance sheet.  When they show up, ask questions.  “Why is this number negative?”  Negative receivables are payables (do you owe someone money instead of them owing you?)  Negative payables are receivables (have you overpaid someone?) 

Ask for the bank reconciliations if your bank accounts don’t reflect what you think should be available.

Look at the Receivable Aging Summary to verify it matches the financial statement.  Look at the details for old balances and large amounts owed by questionable customers. “Cash is Cash” – no sale is complete until the receivable is collected).   Has there been an appropriate adjustment of uncollectable receivables? 

Each line of the balance sheet represents cash.  Assets are either cash in the bank, cash to be collected, assets being sold to be converted to cash, or cash spent for the infrastructure that is needed to supply the solution for solving customers compelling needs for which cash is received.  Liabilities are cash that must be paid out for goods and services or loans received.  Equity is the net result of cash received net of cash paid out even if it’s the value expressed in cash for trade.

When it comes to understanding your business, financial statements are like the EKG your doctor uses to assess the health of your heart.  Knowing what every peak and valley on the printout means can tell your physician whether you’re in good health or whether it’s likely he will soon be sliding you into a drawer.

Joe Day, CPA is a Certified Public Accountant who specializes in medical practices.