Why Understanding Your Financial Position Is Important
As an entrepreneur, it is important to have a good understanding of your financial information. Everyday decisions could be greatly enhanced by using your balance sheet, income statement, and other underlying financial data. You can change business direction, increase revenue streams, and learn how to analyze your expenses to increase your bottom line. Below is what to look for when analyzing your financial position and how understanding your finances can assist in the operation of your business.
Understanding your overall financial position.
This has to do with working capital, assets versus liabilities, earnings that are being retained within the company, your leverage, and knowing if you are fully capitalized.
Understanding your cash balance at all times is critical. Your cash is the heartbeat of your company. Reviewing a cash flow analysis, at least monthly, is critical to know where you are spending your money and if it's beneficial.
The accounts receivable balance represents future cash flow. It is a must to review your accounts receivable aging and gain an understanding of slow pay and delinquent accounts.
Building processes and procedures around the collection process are critical to where adequate capital is available to sustain your operations.
If you don't get paid, that is worse than actually making a sale, because you have costs tied into that balance that creates a loss on your income statement.
Inventory levels are critical.
Companies tend to accumulate excess inventory, which becomes slow-moving.
You also need to look at obsolescence on a timely basis and determine if you could have a bulk sale to remove slow-moving inventory.
Decide if you are taking up valuable space in your warehouse, or if you are carrying something that may never sell.
With this, if you are in the construction business, or in any kind of industry where there are long-term projects you must understand the proper capitalization of costs and deferral of income. Comparing revenues and expenses during the correct accounting period is the only way that you will truly understand your economic reality.
In the liability session, you need to understand how much you actually owe your vendors and your debt capacity.
This means understanding accounts payable which are largely vendor invoices that need to be entered into the system promptly.
Therefore, you should be able to match revenues and expenses in the same financial period. Which is typically a month.
Understanding if you are over or under-leveraged is critical.
Are you properly capitalized as a business?
Debt capital is the cheapest capital that you can receive, therefore, increasing your line of credit over proper intervals is very important to sustaining your business.
There could be a downturn in which you need to utilize the line.
Understanding your income statement that defines the results of operations and sustainability of your net income.
Where are your revenues coming from?
It is important to have business segments laid out in your income statement. In QuickBooks, they are called classes.
How does your gross profit compare with industry standards?
There is numerous data basis that could be utilized to compare these statistics.
You should understand your industry and set proper expectations.
Understanding your concentration of credit risk is important to mitigating it. This could involve having a few large customers that make up a large percentage of your total revenues.
Are your human capital needs adequate to substance net income or are you over-employed?
Typically this computation would be looked at on a common-sized basis, which means wages and salaries as a percentage of that revenue.
You can then compare numerous accounting periods to determine if you are in line with industry standards.
Operating expenses, are you overspending in certain areas?
This computation can also be determined using a common size analysis, where you make comparisons over several accounting periods.
Other operating expenses.
Should you purchase a building versus paying excessive rent?
Are you underspending in advertising?
Make sure you have an analytic tracker attached to your website or ads. Measure and monitor what you are spending and how it is increasing revenues.
Common size analysis.
A preferred way to analyze operating expenses is by using a common size analysis. Computing each operating expense as a percentage of net revenues.
You can gain an understanding of real expense growth and how it will impact net income.
Non-financial reports can then be generated from your income statement, balance sheet, and general ledger.
These are typically generated from downloading information from QuickBooks to Excel.
This would be considered drilling down into your financial data.
Areas that you can detect as underutilization of work capacity, individual employee effectiveness, actual production for defined periods, cash flow issues, sustainability of your working capital, and sustainability of your earnings.
Your numbers can help you make decisions and be well-informed of your business performance under various circumstances. These decisions can range from hiring personnel, shifting your revenue growth, pivoting to new business opportunities, and controlling expenses.
We help businesses every day to understand their financial data by covering these topics. If you are looking to drill down into your finances in order to make better-informed business decisions, contact us today!