The Importance of Financial Analysis for Business Success

When I think about a business's success, financial analysis immediately comes to mind.  How are business owners reviewing their financials?  Are they using an accounting system or relying on Excel worksheets? 

​It's crucial for small business owners to understand the significance of performing financial analysis.  To grasp the monthly activities of their business, owners should be familiar with the following aspects of financial statement analysis:

Key Elements of Financial Statement Analysis

1. Trends. Identify trends by creating trend lines for key items in the financial statements over multiple periods.  This helps in assessing the company's performance.  Common trend lines include revenues, gross margin, net profits, cash, accounts receivable, and debt.
2. Proportion analysis. Utilize various ratios to understand the relationship between different accounts in the financial statements.  For instance, the quick ratio estimates a company's ability to pay its immediate liabilities, while the debt-to-equity ratio indicates if the company has taken on too much debt.  These analyses often compare revenues and expenses on the income statement with assets, liabilities, and equity on the balance sheet.

The Power of Financial Statement Analysis

Financial statement analysis is an exceptionally powerful tool for various users, each with different objectives in understanding the financial circumstances of a business.

Users of Financial Statement Analysis

• Creditors. Lenders are interested in a company's ability to repay debt, focusing on cash flow measures.
• Investors. Both current and prospective investors examine financial statements to assess a company's ability to issue dividends, generate cash flow, or maintain growth.
• Management. The company controller conducts ongoing analysis of financial results, particularly in relation to operational metrics not visible to outsiders (e.g., cost per delivery, cost per distribution channel, profit by product).
• Regulatory Authorities. For publicly held companies, financial statements are reviewed by the Securities and Exchange Commission (SEC) to ensure compliance with accounting standards and SEC rules.

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​As a business owner, have you ever felt left out of a conversation when others start to talk about their financial statement reports?  When you start to hear words such as, P&L, profit and loss, statement of earnings or income statement --- the conversation may start to feel a bit awkward and overwhelming. That’s why we’re going to dive into how to understand more these statements.
 
Understanding the income statement is essential to business owners and investors as it provides an overview of the profitability and future growth of your business.  All business owners should see the income statement as a simple and straight forward report on a business’s cash generating ability.  It is a scoreboard on the financial performance of your business that reflects when sales are made and expenses are incurred.
 
The official definition says an income statement is:
 
A financial statement generated monthly and/or annually that reports the earnings of a company by stating all relevant revenues (or gross income) and expenses in order to calculate net income.  Also referred to as a profit and lost statement.
 
The income statement is one of the five financial statements issued by a business.  It reports the amount a corporation has earned during the period between two balance sheet dates.
 
Here are 3 things you should know about an income statement:
 
Income Statements come with Accounting Jargon
One thing that can make entrepreneurs shy away from financial statement conversations is the jargon used.  The jargon can make it seem more complex than it really is.  For example, the term “sales” or “income” might be used instead of revenue.  “Expenses” and “costs” are also used interchangeably.  “Profit” is sometimes called “net income. 
 
Income Statements cover a period of time
The income statement reveals how much money your business made over a period of time.  Most often, the statement will reflect the performance over a month, a quarter or a year. 
 
For example, you might hear the words, year to date, or see “Y-T-D December 31”, indicating the period for Jan 1 to Dec 31. 
 
Income Statement follows a formula
Every income statement, no matter how complex, follows a very simple formula.
 
Revenue – Expenses = Profit
 
For the period specified on the income statement, it will show the revenue the business earned, the expenses it incurred and the profit it made.
 
If you want to understand how your business operations flows, the income statement can help give you a better picture of what makes your company profitable and where the losses are coming from.

​Well, maybe this blog will not make you snuggle up with an Accounting book at night and call it your BFF but I will go for making you two close friends.  Close friends because you need this person in your life for your business to be successful. 
 
There are millions of small business owners and startup entrepreneurs who are masters at creating products and services and winning over customers.  However, many of them are weak in understanding the accounting area of the business.  To be effective in grasping the concept of accounting, I find it useful to understand some of the commonly used terminology.  Essentially, accounting is about managing debits and credits.  Those debits and credit are recorded and managed by the business owner, consultant or bookkeeper of the business, mainly to ensure money is coming into the bank and expenses are being paid timely.

​The American Accounting Association (AAA) defines accounting as “the process of identifying, measuring and communicating economic information to permit informed judgement and decision by users of the information.”
 
The basic formula to accounting is: Assets = Liabilities + Equity (Owner’s equity)

Knowing the basics equation, outlined above, will assist in the understanding of accounting account types.
 
There are different types of accounts in which debits and credits are kept track of in accounting, let’s define some them,

• Assets are financially measurable resources that a company owns.  Some examples of those are cash, supplies, property and equipment.  While reputation may be important to an entrepreneur and valuable when it comes to gaining new customers, it is not measurable thus not accounted for as an asset in the business.

• Liabilities are the financial obligations of the company, basically debt.  Every business will have it but the key here is keeping track of it accurately. 

• Equity is the dollar value of the company’s worth. 

• Revenues are the dollar amounts of income that are earned whenever the business provides a service or sells a product. 

• Expenses are the cost associated with running the business, including bills. 

 
When managing your business, these definitions will be used quite frequently especially if you have hired a consultant or bookkeeping to manage the accounting area of your business.  Let’s say your current business is a hair professional in a Salon and at the end of the day your analyzing how much you made for the day. 
 
Your recording book shows:

• 2 Clients, $60 each    
• 6 Products sold
  • 3 Hair spray, $10 each
  • 1 comb, $5
  • 2 Conditioners $ 10 each (owner ‘s product)

 
The owner of the salon may generally record total earned revenues of $175.  However, to an accountant or bookkeeper they are also concerned with how much it cost (expenses) the Salon owner to make the two conditioners she sold for $10 each and how much was it to purchase the comb and hair sprays.  Understanding this information gives the true net revenue amount of how much the salon owner made for her one day of work.
 
The take away here, is to remember it takes more than developing marketing techniques and creating new products and services to manage a business.  As a business owner, your accounting processes and methods used to analyze should be your BFF in the business because without it, you can never know where it stands or how healthy or unhealthy it is.
 
If you understand the importance of accounting to your business and are ready to protect your business from financial risk, visit our website to schedule your consultation.

When an idea is developed into a business, establishing the accounting processes to track the revenue and expenses is generally not on the top of the list. 
 
A chart of accounts short name is (COA) and is defined as “a listing of the names of accounts that a company has identified and made available for recording transactions in its general ledger.”  A chart of accounts has standard accounts you may see despite the industry of business you work in.  However, typically the order of the accounts are as follows:
 
Balance sheet accounts:

• Assets
• Liabilities
• Owner’s (Stockholders’) Equity

 
Income statement accounts:

• Operating Revenues
• Operating Expenses
• Non-Operating Revenues and Gains
• Non-Operating Expenses and Losses

Your account receivables are considered an asset, and so is your income but they are two completely different things.  Account receivables are created by the sale of goods or services but income is what you have received from the sale of goods or services.  You see, if you bill a customer and give them time to pay it is accounts receivable, and when you receive the money via deposit into your bank account then that is income.
Many business owners may be using an accounting software to manage their chart of accounts.  The software may provide a list of custom accounts to use but it will be the responsibility of the respective business owner to add custom accounts to ensure finances are recorded accurately.
 
Below is an example of the chart of accounts for a Salon professional:
 
Assets:

• Petty Cash
• Savings Account
• Supplies Inventory
• Employee Advances

Examples:  Assets ask the question of what does your company own?  They either are actual money (checking, savings) or they could be converted to money.
 
Fixed Assets:

• Furniture & Fixtures
• Equipment
• Land

Examples:  Fixed assets relate more to physical property.
 
Expenses:

• Advertising Expense
• Commissions and Fees Expense
• Licenses Expense
• Rent or Lease Expense

Examples:  Expenses ask the question of what do you regularly have to spend money on, no matter what?  Utilities? Telecommunications cost?
 
A chart of accounts generally serves as an outline for the business structure and is a tool for gathering and organizing financial information.
 
The chart of accounts example below is one sample guide.
 
It identifies the account name (A), this name will depend on your type of business and sub-group (B), is dividing the chart of accounts into groups for financial representation and normally (C), indicates whether the account is normally increased by a debit entry or credit.

For example, depending on the size of business the leader may have one individual responsible for reconciling all of the cash accounts to ensure online, in-store or one-time made purchases are all accounted for on a daily basis.  But, in another business the leader may assign cash and accounts receivable to one individual (not recommended, but could happen) and they would be responsible for ensuring all cashed is received and accounted plus for in addition,
 
The debit and credit column indicates whether the account is normally increased by a debit or a credit.  As an example, expense accounts are normally increased by a debit entry but income accounts are increased by a credit.
​
If your looking to strengthen the accounting processes of your business, Fontenot & Associates Solutions LLC has the skills and tools to get you started.  Even though your business may be a one person shop,  the organization of your finances should be accurate and organized from day one.

​Getting started is simple, let us show you how.

How does one define a non-profit organization?  It has been defined as entities that perform charitable services by accepting funds from the general public. To help regulate the activities and encourage proper allocation of funds, accounting standards have been put in place by the Financial Accounting Standards Board also known as FASB.   The accounting standards are used by management of non-profit organizations as a guide to record transactions and comply with program requirements.

Many non-profit organizations exist to accomplish a goal and not to return a profit however as funding opportunities present themselves and partnerships begin to form, the financial statements will need to be accurately managed by a designated accountant or management.  The finances are generally budgeted and every line item within the financials are accounted for.  The operational budget is the foundation from which all of the work will be carried out.  It allows you to establish benchmarks and determine priorities.  In addition, it brings light to the variable cost which may exist and allows management to analyze and change the to fixed cost.




Here are some key steps in developing your budget:

• Establish a reasonable written budget and period (one year or multiple years)
• Decide who should be involved and when (timing become key during this process)
• Review program achievements and if in start-up phase be aggressive in seizing funding opportunities
• Set program and organization goals for your budget inclusive of specific task and responsibilities
• Establish internal goals your volunteers, leaders and potential partners can identify with appreciate
• Estimate expenses, stray away from variable and unpredictable expenses
• Estimate anticipated revenue
• Plan for needed cash flow
• Identify potential fundraising activities within your community

These steps are sufficient and valid for a newly established non-profit organization and those who have been established for five or more years.  A well established and maintained budget is what donors look for.  Donors want to know where the money is going.  They want to give their money away to "a worthy cause", and it is management's responsibility to show them that that's what is occurring.

Showing that you're non-profit organization is worthy starts with a good budgeting process which engages those who are responsible for adhering to the budget and implementing the organization's objectives in creating the budget. Get started today with the annual budgeting process, is it documented, with task, responsibility assignments and deadlines clearly state?  It is never too late to get started.  

​Fontenot & Associates Solutions, LLC offers the skills and experience to prepare the annual budgeting procedures in advance which will ensure proper delegation of assignments and the delivery of a clear message.