Understanding Financial Statements

Financial Statements analysis record the performance of your business and allow you to diagnose its strengths and weaknesses by providing a written summary of financial activities. There are two primary financial statements: the Balance Sheet and the Statement of Income.

The Balance Sheet

Financial statement analysis looks first at the balance sheet. The Balance Sheet provides a picture of the financial health of a business at a given moment, usually at the close of an accounting period. It lists in detail those material and intangible items the business owns (known as its assets) and what money the business owes, either to its creditors (liabilities) or to its owners (shareholders' equity or net worth of the business).

Assets include not only cash, merchandise inventory, land, buildings, equipment, machinery, furniture, patents, trademarks, and the like, but also money due from individuals or other businesses (known as accounts or notes receivable).

Liabilities are funds acquired for a business through loans or the sale of property or services to the business on credit. Creditors do not acquire business ownership, but promissory notes to be paid at a designated future date.

Shareholders' equity (or net worth or capital ) is money put into a business by its owners for use by the business in acquiring assets.

At any given time, a business's assets equal the total contributions by the creditors and owners, as illustrated by the following formula for the Balance Sheet:

Assets = Liabilities + Net worth

This formula is a basic premise of accounting. If a business owes more money to creditors than it possesses in value of assets owned, the net worth or owner's equity of the business will be a negative number.

The Balance Sheet is designed to show how the assets, liabilities, and net worth of a business are distributed at any given time. It is usually prepared at regular intervals; e.g., at each month's end, but especially at the end of each fiscal (accounting) year.

By regularly preparing this summary of what the business owns and owes (the Balance Sheet), the business owner/manager can identify and analyze trends in the financial strength of the business. It permits timely modifications, such as gradually decreasing the amount of money the business owes to creditors and increasing the amount the business owes its owners.

All Balance Sheets contain the same categories of assets, liabilities, and net worth. Assets are arranged in decreasing order of how quickly they can be turned into cash (liquidity). Liabilities are listed in order of how soon they must be repaid, followed by retained earnings (net worth or owner's equity).

The categories and format of the Balance Sheet are established by a system known as Generally Accepted Accounting Principles (GAAP). The system is applied to all companies, large or small, so anyone reading the Balance Sheet can readily understand the story it tells.

Balance Sheet Categories

Assets and liabilities are broken down into categories as described as follows:.

Assets: An asset is anything the business owns that has monetary value.

Current Assets include cash, government securities, marketable securities, accounts receivable, notes receivable (other than from officers or employees), inventories, prepaid expenses, and any other item that could be converted into cash within one year in the normal course of business.

Fixed Assets are those acquired for long-term use in a business such as land, plant, equipment, machinery, leasehold improvements, furniture, fixtures, and any other items with an expected useful business life measured in years (as opposed to items that will wear out or be used up in less than one year and are usually expensed when they are purchased). These assets are typically not for resale and are recorded in the Balance Sheet at their net cost less accumulated depreciation.

Other Assets include intangible assets, such as patents, royalty arrangements, copyrights, exclusive use contracts, and notes receivable from officers and employees.

Liabilities: Liabilities are the claims of creditors against the assets of the business (debts owed by the business).

Current Liabilities are accounts payable, notes payable to banks, accrued expenses (wages, salaries), taxes payable, the current portion (due within one year) of long-term debt, and other obligations to creditors due within one year.

Long-Term Liabilities are mortgages, intermediate and long-term bank loans, equipment loans, and any other obligation for money due to a creditor with a maturity longer than one year.

Net Worth is the assets of the business minus its liabilities. Net worth equals the owner's equity. This equity is the investment by the owner plus any profits or minus any losses that have accumulated in the business.

The Statement of Income

The second primary report included in a business's Financial Statement is the Statement of Income. The Statement of Income is a measurement of a company's sales and expenses over a specific period of time. It is also prepared at regular intervals (again, each month and fiscal year end) to show the results of operating during those accounting periods. It too follows Generally Accepted Accounting Principles (GAAP) and contains specific revenue and expense categories regardless of the nature of the business.

Statement of Income Categories

The Statement of Income categories are calculated as described below:

Net Sales (gross sales less returns and allowances)

Less Cost of Goods Sold (cost of inventories)

Equals Gross Margin (gross profit on sales before operating expenses)

Less Selling and Administrative Expenses (salaries, wages, payroll taxes and benefits, rent, utilities, maintenance expenses, office supplies, postage, automobile/vehicle expenses, insurance, legal and accounting expenses, depreciation)

Equals Operating Profit (profit before other non-operating income or expense)

Plus Other Income (income from discounts, investments, customer charge accounts)

Less Other Expenses (interest expense)

Equals Net Profit (or Loss) before Tax (the figure on which your tax is calculated)

Less Income Taxes (if any are due)

Equals Net Profit (or Loss) After Tax

Calculating the Cost of Goods Sold

Calculation of the Cost of Goods Sold category in the Statement of Income (or Profit-and-Loss Statement as it is sometimes called) varies depending on whether the business is retail, wholesale, or manufacturing. In retailing and wholesaling, computing the cost of goods sold during the accounting period involves beginning and ending inventories. This, of course, includes purchases made during the accounting period. In manufacturing it involves not only finished-goods inventories, but also raw materials inventories, goods-in-process inventories, direct labor, and direct factory overhead costs.

Regardless of the calculation for Cost of Goods Sold, deduct the Cost of Goods Sold from Net Sales to get Gross Margin or Gross Profit. From Gross Profit, deduct general or indirect overhead, such as selling expenses, office expenses, and interest expenses.

to calculate your Net Profit. This is the final profit after all costs and expenses for the accounting period have been deducted.

Evaluate your budget periodically with actual operations figures. With effective records you can accomplish this. Afterward, where
discrepancies show up you can take corrective actions before it's too late. The proper decisions for the ideal corrective action
will depend upon your understanding of management techniques in purchasing, pricing, selling, selecting and training staff, and
handling other management issues.

You probably are thinking you can hire a bookkeeper or a Accountant to deal with the record keeping for you. Yes, you can. But
remember two very important details:

1. Provide the accountant with true input. If You Purchase something And don't record the sum in your organization checkbook, the
accountant can not enter it. If you sell something for cash and do not record it, then the accountant will not understand about
it. The records the accountant prepares will be no better than the info that you provide.

2. Use the documents to make conclusions. If you went to a physician And he told you you were sick and wanted certain medicine to
get well, you'd follow his advice. Should you pay an accountant and he tells you that your earnings are down this season, do not
hide your head in the sand and pretend that the issue will go off. It won't.

Business Management Roll in Personnel Selection. If your Small Business Will be big enough to require external help, an important
responsibility will be the choice and training of one or more employees. You may begin with family members or business partners to
help you. But when the company grows - as you expect it will - the time will come when you must select and train personnel.

Careful selection of personnel is essential. To select the right Employees determine beforehand what you want each one to do.

Then look for applicants to fill these specific needs. In a small Business you will need flexible employees who can shift from
task to task as needed. Include this in the outline of all the jobs you wish to fill. At precisely the exact same time, look ahead
and plan your hiring to guarantee an organization of individuals capable of performing every essential role. At a retail store, a
salesperson may also do stock-keeping or accounting at the start, but as the business grows you will need sales people,
stock-keepers and bookkeepers.

When the job descriptions are composed, line up applicants from whom To make a choice. Do not be swayed by customers who may
suggest relatives. In the event the applicant does not succeed, you might drop a client in addition to a worker. Some sources of
possible new employees are:

1. Tips by friends, business acquaintances. 2. Employment agencies. 3. Placement agencies of top schools, business schools, and
schools. 4. Trade and industrial associations. 5. Help-wanted ads in local papers.

Your next task is to display want ad responses and/or application Forms sent by employment agencies. Some applicants will be
eliminated sight unseen. For every one of those other people, the application form or letter will serve as a basis for the
interview which should be conducted in private. Put the applicant at ease by describing your business in general and the
occupation in particular. As soon as you have done this, encourage the applicant to speak. Selecting the proper person is very
important. Consult your questions carefully to find out everything about the applicant that's pertinent to this job.

References are a must, and should be checked prior to making a final decision. Check through an individual visit or a phone call
directly to the applicant's immediate former supervisor, if at all possible. Verify that the information given you is correct.
Consider, with conclusion, any negative comments you hear and what isn't said.

Checking references may bring to light important Details Which may help save you money and future annoyance.

Personnel Training. A well-selected worker is only a potential Asset to your organization. Whether or not he or she becomes a real
asset depends upon your own training. Recall:

To allow sufficient time for instruction. Not to anticipate too much from The trainee in too short a time. To let the employee
learn by performing under actual working conditions, together with close oversight. To follow along with your training.

Check the employee's operation after he or she has been in work For a time. Re-explain key points and short cuts; bring the
employee up to date on new developments and invite inquiries. Training is an ongoing process which becomes constructive oversight.

Personnel Supervision. Supervision is the third crucial of employees control. Fantastic supervision will lessen the expense of
operating your business by cutting back on the number of worker mistakes. When mistakes are corrected early, employees will get
more satisfaction out of their tasks and perform much better.

Motivating Employees. Small businesses sometimes face particular Problems in motivating employees. In a large business, a good
employee can see An opportunity to advance into management. In a small company, you are the management. One thing you Might Wish
to Think about would be to give good employees a Small share of the proceeds, either via part-ownership or even a profit-sharing
plan. Someone who has a"share of the activity" will be more Worried about helping to make a success of the business.

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