Is This Your Situation: Interpreting Your Financials
QuickBooks creates a framework around your debits and credits. If, however, data are not entered correctly or if you don’t understand how to interpret the financial reports, you aren’t getting the insight you need on your business.
Keeping a close eye on current financial statements is an integral component of good business decision-making. These numbers say a lot about your business. Consider the following:
- Are you making money this month, quarter or year?
- Is there enough money in the bank to pay for current payroll, fixed expenses and inventory purchases?
- Are your fixed assets fully depreciated and in need of replacement?
- Are your current payables to vendors larger than your current receivables from customers?
- How much in taxes will be owed on current-year profits?
- What is the current equity position of the company?
Your financial statements can tell you so much about what’s happening in your business today and what you likely can expect for tomorrow.
First, you should intimately learn two critical financial statements:
- Balance Sheet: This reveals what a company owns and how much money it owes at any point in time.
- Income Statement: This statement shows how much money a business has made and how much it has spent over a certain period of time.
When looking at a balance sheet, the three most important items to note are assets, liabilities and equity. Assets are anything owned by the company that has a future value (cash, receivables, equipment, trademarks). Liabilities are the amounts owed to others (vendors, banks, credit cards). The difference between what you own and what you owe, is your equity. If the equity portion of your business is a positive number, that’s a good thing. If equity is a negative number, your business is losing value.
The three most important aspects of an income statement are gross profit, operating expenses and net income. Gross profit gives you insight into your sales and the associated costs to produce those sales and can help you determine whether your gross margin is adequate. Isolating your overhead expenses is key. You’re in business to earn money, so if you don’t have enough gross profit to cover these expenses, you will be operating at a loss.
What Do the Financials Say About Tomorrow?
The availability of working capital, often expressed as the excess of current assets over current liabilities, is important to sustain a company into the future. Extending too much credit to customers, and noncompliance with vendor or creditor terms can lead to the insolvency and ultimate closure of a business. Additionally, if a business continues to show no profit, eventually, it will not have any cash left to continue operations.
Various ratios and analytical computations can be used to predict the financial future of a business. Following are some common measurements that can be found within the balance sheet and income statement:
- Current Ratio: Current Assets/Current Liabilities. Used to determine the ability of an enterprise to meet current obligations.
- Accounts Receivable Turnover: Net Sales on Account/Average Accounts Receivable. Used to assess the efficiency in collecting receivables and the management of credit.
- Inventory Turnover: Cost of Goods Sold/Average Inventory. Used to assess the efficiency in the management of inventory.
- Ratio of Stockholders’ Equity to liabilities: Total Stockholders’ Equity/Total Liabilities. Used to indicate the margin of safety to creditors.
Understanding these accounting terms is another device in your toolbox as you build and grow your business. If you want more help using QuickBooks to accurately interpret your financials, call us today.