Everyone likes a good story. Stories pull you in, keep your interest and in many cases leave you with more knowledge than you started with. Financial statements have many perceived roles (requirement for lenders and bankers, benchmarking with peers, input for taxes to name a few), however the powerful role that financial statements play to tell the story of your business is often overlooked.
While the creation of financial statements can be complicated with interdependencies that often require the involvement of an accounting or finance professional, what these statements reflect goes far beyond the accounting technicalities. These numbers represent the every day operations of the business. Historical income statements and balance sheets reflect the outcomes of strategic initiatives and the results of key decisions. It is this direct correlation between business decisions and financials that makes understanding your financial statements so important for business owners.
During conversations with business owners over the years, I have noticed that there is a tendency to minimize the importance of truly understanding their financials. Executives and business owners recognize the need to produce quality financial statements for accounting and tax purposes but may fail to take it a step further to use those same financials as a tool for making future strategic decisions. The reasons for this are varied. Lack of confidence in financial knowledge, limited time, reliance on outside advisors or the internal team to tell executives “what they need to know” are a few. Under-utilizing your historical financial statements as an effective management tool can result in uninformed decisions that can have dire consequences for your business.
By taking a proactive approach to regularly assessing your business’s financial performance at specific intervals (monthly and quarterly – not just at year end), and by establishing targeted performance metrics, you are running your business from a position of enhanced visibility and strength. Financial statements are thus transformed from an accounting output to a lens into your business to fuel growth. Using your financials to ask and answer key questions provides valuable insight into your business and serves as an important barometer for future operating decisions.
Here are a few key questions to ask yourself when looking at your financial statements in order to gain valuable insight:
- Revenue Trends:
Are sales consistently up or down over the past 12 months and why? What product or service lines are experiencing the most revenue volatility? What is driving this? What is the revenue mix today and how does this align with demand and market trends?
- Cost of Goods Sold:
What are the primary direct costs (cost of goods sold or COGS)? What are the opportunities to drive these costs lower? What is your gross profit margin and how has this been changing over the past several quarters? How does your gross margin align with your peers? What levers can be tweaked to drive gross margins?
- Operating Profit:
What are the biggest operating expenses in your business and how is this evolving? What are the top 3 expenses as a percentage of total SG&A (Selling, General, & Administrative costs) and of revenue? What are the variable expenses vs. fixed? What expenses need to be increased to drive new initiatives forward and what investments need to be made (i.e. new hires, geographic expansion, product R&D?)? What can be pared back? How do your operating margins compare to those of competitors?
Beyond financial knowledge for internal decision-making, there is another crucial role your financial statements can play. They can communicate your company’s value and story to the outside world. Potential investors, lenders, customers and partners are all eager to understand your business and look to a common language to do so. Use your financial knowledge to provide the whole picture of your company’s history and growth and to enable the outside world to truly see the value proposition of your business.
For example, if you are trying to communicate the following, use your financial statements to lend credibility and support:
- Are you a fast growing leader in your space? Back this up with financial metrics highlighting growth trends and use comparisons to peer companies when possible to demonstrate leadership.
- Do you have a strong revenue forecast for the next 12 months? Support this with historical financial growth metrics and a quantifiable pipeline.
- Is your business self sustaining and able to fuel future investments? Demonstrate this with profitability metrics over a period of time along with balance sheet metrics and ratios.
Financial statements tell the story of your business – where it has been in the past, where it is today and to some extent, how strongly positioned it is for the future. It may seem daunting, but taking the time to understand, monitor and articulate your financials will go a long way in achieving your growth strategy or landing that big investment.
Erin Lucien’s business, Springstone Advisory Services povides a range of corporate development consulting services that enable organizations to achieve growth objectives and maximize results in a future capital raise, M&A event or strategic partnership.
Erin has over 15 years of experience in merger and acquisition transaction advisory, strategic consulting and valuation services. Over the course of her career, she has been involved in the execution and evaluation of sell-side and buy-side transactions for over 20 technology companies.
You can view her profile HERE.