Financial Statement Analysis
The financial statement analysis of any company large or small is the lifeblood of its success. And while large companies can afford staff accountants or even CPAs, the small business owner in America often stays up late at night pouring over statements that bewilder and even intimidate. While a small enterprise owner may pay the ultimate price for failure to make an accurate statement analysis, large corporations bring a tidal wave of human economic loss when deceit and corruption in accounting practices are tolerated. With the meteoric impact on human lives that a recent large corporation's cooked books (a euphemism for showing a financial success story when there is none) brought to the financial markets, the government is looking into the ethical standards of business financial statements of both large and small companies more than ever.
The most important thing a wise and prudent assessment of fiscal records can bring to any business owner is the early detection of trends and problems. Ignoring an oncoming money crisis by not observing bends or sharp curves in the fiscal road can spell eventual disaster. The bones of many entrepreneurs have been left on the seashore of ignorance, fool hardiness or just greed, all because of failure to deal with the realities of their business financial statement. In addition the ability to make a sound financial statement analysis can also be a tremendous advantage when looking at companies stocks and deciding whether they are a prudent investment or not. The following items are only a few of the components of a fiscal business statement.
Cash flow is a quarterly read on the money entering and exiting a company's books. It is not profit, but rather a look at the flow of transactions that took place in that quarters commerce. In a small business with little reserve in place, a negative cash flow can mean the owner pays everyone else first, and if nothing is left over, the owners family has soup for supper. For the small venture owner, slow paying monthly clients or customers are the cause of hardened financial arteries. While the owner must continue to pay a staff and all the expenses of the venture, the knowledge that there will eventually be a profit on the outstanding invoices that are late may often not be of much comfort. An accurate business statement analysis by an owner who is often on the road drumming up new trade will often reveal a cash flow problem early enough to head off a crisis back home.
Expenses are another component of the business financial statement. Perhaps this line has caused more consternation in board rooms and back rooms than any other item. While the expenses such as rising jet fuel costs and higher diesel fuel can often be accepted as inevitable by corporate America, and those expenses can just be passed on to consumers, a business financial analysis that reveals that more and more toilet paper is being used but the staff size remains the same, or that the annual company picnic ran $300 dollars over budget, can send a small business owner into a tailspin. It can be particularly debilitating if the owner cannot raise the price of the product to cover a large number of these expenses that might show up on a quarterly report.
A third component of a financial statement analysis can be a look at the liabilities of a company. While some CEOs might think that their marketing department is the company's largest liability, a liability on a business financial statement is a drain on the company's ability to make more profit that can be measured. An analysis of a company's liabilities will reveal things like interest paid on loans, taxes paid on property, and depreciation of company assets such as vehicles, tools, buildings, computers, etc. The government has devised different depreciation rates for various company assets so that a portion of those assets can be deducted each year as expenses. For the small firm owner, the size of these liabilities may make the difference between profit and loss at the end of the year. For the large corporation, it might mean the difference between boos and cheers at the annual stockholder meeting.
A fourth piece is the balance sheet. If a busy small company owner driving out of state to visit a new client or a CEO rushing out the door to fly to Paris needed a bottom line snapshot of everything that was happening financially at their respective businesses, the balance sheet would give them the real time picture of the company at that moment. It shows whether assets or liabilities are tilting the scales, so to speak. In the first few years of a new venture, it may be an accepted fact that the financial statement analysis may show many more liabilities than assets, therefore, little or no profit. In the white hot heat of reality however, a company will eventually close its doors if the scales continue a negative trend, thus the term balance sheet.
The bottom line is that a careful, well-run company will know the value of precise business financial statement dissection. As a doctor who has trained for years to wield a laser in such a precise manner as not to harm healthy tissue, so will the owners and leaders of business will make themselves masters of their craft: making a handsome profit by careful scrutiny of all the costs and benefits. "Yea, doubtless, and I count all things but loss for the excellency of the knowledge of Christ Jesus, my Lord: for whom I have suffered the loss of all things, and do count them as dung, that I may win Christ." (Philippians 3:8)
Cash Basis AccountingSimple cash basis accounting is more frequently used by small businesses and those that do not use or extend credit. Similar to making entries in a checkbook ledger, accounting in hard cash gives owners a running tally of monies received and funds paid out the moment the transactions occur. Money receipts are recorded one transaction at a time and there are no expectations of future dates of payment. Business owners operating on a strict cash basis can track cash flow and assess on a daily basis whether an enterprise is making a profit or not. Similar to making entries in a checkbook ledger, cash basis accounting lists each sale and each expense, adding and subtracting transactions from a total operating budget. The process is the same even when owners use popular accounting software rather than antiquated ledger books.
Mom and Pop enterprises, shoestring startups, and sole proprietorships generally operate with cash basis accounting. These businesses depend on paying customers to stay afloat and provide sufficient revenue to purchase inventory and stock store shelves. Smaller businesses invest a significant amount of startup capital in new businesses, and are usually extended a certain amount of credit through bankers and lending institutions. But small businesses cannot operate for very long on credit or limited capital. Every dollar counts and every customer must be a paying customer in order for small owners to pay suppliers, repay bank loans, and keep up with overhead expenses.
Most businesses fail in the first five years of operation largely due to a lack of capital or insufficient cash flow. Smaller businesses simply cannot compete with larger entities that can afford to extend credit or run an enterprise from the interest consumers pay for the privilege of delaying installment payments. A small entrepreneur can quickly get into trouble extending credit for which payments fall into default. The resulting lack of cash flow can spell bankruptcy if owners don't watch the bottom line. Consumers have a moral obligation to creditors who depend on timely payments to stay in business. Ecclesiastes 5:4-5 admonishes, "When thou vowest a vow unto God, defer not to pay it; for He hath no pleasure in fools: pay that which thou hast vowed. Better is it that thou shouldest not vow, than that thou shouldest vow and not pay."
Businesses that extend credit, or promises to pay at a later date, use accrual based accounting, a more sophisticated method of tracking profitability. Instead of recording monies that are actually received, revenue is entered when it is earned, although payment may actually be received at a much later date. Credit card issuers, lending institutions, building contractors, and other businesses that allow consumers to pay on time or via installments operate on an accrual basis. These businesses deal with account payables and account receivables, instead of cold hard currency. Accurately determining cash flow in an accrual based business can be more difficult, because transactions are open ended. Customer accounts, while recorded as revenue, are outstanding until payments are actually received. Companies that extend credit run the risk of "counting the proverbial chickens before the eggs hatch." On the books, a business can look like it is in the black, but if customers routinely default on payments, what appears to be assets can easily turn into liabilities. Yet, in spite of the potential precariousness of accrual-based bookkeeping, the Internal Revenue Service (IRS) and the U.S. Securities and Exchange Commission (SEC) require that publicly traded companies follow Generally Accepted Accounting Practices (GAAP), which specifies accrual based accounting.
Unlike the Mom and Pop grocery around the corner, the global monetary system, or money market, operates on accrual based accounting. Corporations, conglomerates, mutual funds, lending institutions, and credit unions depend on interest accumulated from credit extended to consumers. Rather than getting paid at face value at the time of a purchase, businesses can realize significant earnings from interest payments on credit purchases extended 90 days, five years, and more. Accrual-based bookkeeping records principal payments as assets, regardless of when consumers actually pay the balance of purchases made over a period of time. Companies that use cash basis accounting may not have sufficient capital reserves to extend credit and wait on payments. For smaller firms and start-ups, dollar-for-dollar bookkeeping is the safer method of keeping track of cash flow and net profits.
Companies that file federal income tax returns must indicate the bookkeeping method used during the tax year on Schedule C, Profit or Loss from Business, along with Form 1040. Whether cash- or accrual-based, the method must accurately reflect income. IRS guidelines require businesses to use the accrual method for sales and purchases of inventory items. Entrepreneurs using money-based bookkeeping must show all taxable income received when it was credited to accounts, less actual expenses paid. Accrual-basis taxpayers report income in the fiscal year it was earned, regardless of whether monies have been collected. Expenses are deducted even if they have not been paid in the year in which taxes are filed. Bookkeeping methods can be changed in order to reflect accrued sales in one tax year which may not have been received until the following year. Owners may consult the Internal Revenue Service website to determine when to use accrual based accounting or cash basis accounting, or the procedure for making adjustments due to changes in bookkeeping methods. Bankers, certified public accountants, and tax preparers may also be helpful in determining the best method of recording income and expenses and complying with IRS and SEC regulations.