As small businesses begin to grow in scope and size, managing every aspect of the company becomes increasingly difficult. Many of the entrepreneurs I have worked with in the past had a clear vision of where they wanted the company to go, but often lacked the tools needed to have enough insight about the company’s operations to know what was really holding them back. The financial statement could be your answer.
Your Most Powerful Tool
A monthly financial statement is likely the most powerful tool for judging the health and performance of your company. The income statement and balance sheet are unbiased scorecards. They provide timely feedback to owners and executives about what is going on. Structured and used properly, a financial statement alerts management to problems and potential challenges looming.
When I look at the structure of financial statements for small businesses, I often notice 2 common themes about them. First, there is either no balance sheet regularly produced, or if there is, it is very lacking. Second, the income statements either have only the current period, and year-to-date information. When I do see comparison numbers on an income statement, it is a comparison to previous year.
Financial Statement Comparisons are Key
An income statement without a basis of comparison will not prove to be all that useful. Certainly, it will provide a snapshot of a fixed point in time. However, without a number to compare to, there is not much knowledge to be gained. Financial statements should be a means of gaining insight. If that isn’t happening, then it is just data.
The most common comparison on the income statement is the same period in the previous year and the previous year-to-date. These can be helpful in determining performance changes year over year, but unfortunately, there can also be limitations and challenges.
The biggest challenge with only having a year over year comparison is that you can only look backwards at your business. In most financial reviews I have had where the comparison was based on last year, too much of the meeting is spent on phrases like “Yeah, but remember we had that big expense last year” or, “You can’t go off those numbers, we had a big, one-time sale to that other customer”. These types of distractions are often unproductive and end up causing confusion. This frequently happens at the expense of gaining any valuable knowledge about where the company is going.
A Better Comparison
I am a big advocate of making a plan, and then tracking progress toward the plan. Many business owners and executives tend to agree with this sentiment, but frequently are not able to track progress for anything other than sales dollars. To be sure, knowing your forecasted vs. actual sales is valuable, but equally valuable is knowing how much you are spending in, for example, production labor vs your forecast.
For this reason, I typically advise companies to create a detailed budget, down to the general ledger account level. The result of this budget process provides the management with a budget for every account, every month. This allows you to form a comparison for each period and for the year-to-date expectation.
When this type of budget is in place, the monthly review takes on a very different tone. The questions start to sound more like: “It’s July, and our warehouse supplies cost should be $40,000, why is it already over $60,000?” This is the type of question that usually yields a much clearer picture of things that might otherwise go undetected until year-end.
Closing Thoughts: Data vs. Knowledge
I mentioned earlier that if your financial statements are giving you insight, then it is just data. This is an important concept. “Big Data” is a buzzword and many companies are on a quest to acquire as much of it as possible. What you really want to go after is “Big Knowledge”.
Data is nothing more than facts and statistics. If it is not presented in such a way as to give the consumer new knowledge, then it is worthless. Knowledge is the summation of the facts, information and awareness that come from analyzing the data at hand.
To determine whether or not you are gaining knowledge, ask yourself this question: “Can I use the financial statement to make decisions about the business?” If the answer is no, it may be time to make some improvements. Hopefully this post will help you design a financial statement that can deliver valuable insight into your company.
If Atlas Precision can help jump start your path to a better financial statement, read more about how we work here.