Find the Narrative in Your Financial Statements

Reliable financial statements are essential for every business. Small companies included. To fulfill your vision for your company, you need to use, and understand, your financial statements, with the help of your team: your accountant and your bookkeeper.

The narrative: By design, financial statements summarize past events. They’re only relevant to future action when accompanied by explanations. Simply recording transactions and not studying the resulting financial reports accomplishes little. Similarly, don’t let complacency take over when you receive financial information from a professional bookkeeper. Instead, examine and learn from it.

Understanding all the elements in financial statements is often challenging. For instance, a business may have a profit but insufficient cash. The income statement doesn’t indicate cash paid for unsold inventory, loan payments, new equipment, owner distributions, or income tax payments. Therefore, along with the balance sheet and income statement, a cash flow statement is an important component of financial reports.

Cash in the bank is like insurance against uncontrollable events. For any business, shifts in the market can arise suddenly. Be prepared with enough cash to survive events like reduced customer orders or the need to replace equipment.

If you check the financial statements of a large organization, whose securities are listed on a public stock exchange, you’ll find an analysis and discussion by management. Your bookkeeper can give you access to similar types of information on your company; he or she can highlight major trends, identify recent issues, and point out any red flags in your financial statements.

The significance of financial statements comes in knowing what they convey. Wise business owners, with support from their bookkeepers, are always aware of year-to-date sales, profit margins, changes to primary expenses, debt ratios, payroll hours, and the collection of receivables. They recognize when inventory on the balance sheet isn’t worth the stated cost and when receivables should be written off, as well as the tax implications of selling particular capital assets.

Own the numbers: If an accountant issues a compilation of your financial statements, a cover page will accompany this report. Read the language describing the accountant’s responsibilities. The accountant assumes no responsibility for any of the numbers. Rather, the compilation report clearly states that the figures are the responsibility of the company’s management. Even with fully audited financial statements – which are uncommon for almost any small enterprise, because they’re costly and usually unnecessary – an accountant only provides reasonable assurance that the statements are free of material misstatements.

The takeaway is that company management is responsible for the financials. Hence, you must take ownership of the financial data and understand every line on the statements.

Your business tax return: Be aware that the internally prepared financial statements of a small business are commonly adjusted for tax reporting purposes. Tax returns treat assets differently, don’t allow deduction of some expenses, and distinguish certain incoming cash from ordinary sales income. Ask your accountant to explain how your tax return reconciles to your financial statements. Your financial team members are available to explain the complexities. So use them!