‘READING FINANCIAL STATEMENTS’

1.         You, as an entrepreneur, must understand how to read a financial statement because it is the lifeblood of your business.  Please read the chapter on this subject carefully.

2.         Your accountant will assist you in understanding Generally Accepted Accounting Principles (G.A.A.P.) in more detail. Listen to him/her. Also, it would never hurt to take a course in basic accounting.

¨       Virtually all financial statements consist of four separate reports.

1. THE BALANCE SHEET

2. STATEMENT OF EARNINGS (STATEMENT OF INCOME)

3. STATEMENT OF CHANGES IN FINANCIAL POSITION

4. NOTES TO THE FINANCIAL STATEMENTS

¨       FIFTEEN ‘MUSTS’ ENTREPRENEURS NEED TO KNOW ABOUT FINANCIAL STATEMENTS

1.                  The ratio of Current Assets to Current Liabilities should be a ratio of 1:1 or better. 

2.                  The ratio of Equity (the amount you have invested in the company plus the accumulated profits) needs to be in a reasonable proportion to the Debt. 

3.                  The ratio of Accounts Receivable to Sales indicates if receivables are current.

4.                  The ratio of Inventory to Cost of Sales will indicate if inventory is turning over at the proper rate.  Excessive inventory is indicative of bigger problems.

5.                  The ratio of Fixed Assets to Long-term debt will indicate if long-term assets are being financed with long- or short-term debt.

6.                  Cash Flow is defined as the earnings for the year adjusted for non-cash items (e.g. depreciation). Virtually all business must have a positive cash flow.

7.                  Have a Statement of Changes in Financial Position done if there isn't one.  This optional financial statement will indicate the source of cash and where it was spent.

8.                  Watch the Research and Development (R&D) costs. A product or service that is needed as much in the future as it is now, will reduce future R&D expenditures.

9.                  Leasing of equipment such as office equipment, cars, etc. may not be seen on the balance sheet. These leases must be referenced somewhere in the statements.

10.              Examine the company’s depreciation policy. If the asset has a life of 10 years and they write it off in 15 years, they are showing an artificially higher profit.

11.              If start up and Research and Development (R&D) costs are capitalized (i.e. inserted as a part of the assets), they will artificially increase the profits of the company.

12.              Look for hidden assets. Patents, franchises, contracts with customers giving exclusive rights to sell products, etc. These items can have huge hidden value.

13.              Examine the ratio of Capital Assets to Debt. In times of a cash crunch, the equipment portion of the capital asset can be refinanced - a source of quick cash.

14.              Oil & gas, mining, forestry, agriculture, fishing industries’ balance sheets are different from normal ones. Be an expert, or have an expert help you to read them.

15.              The bottom right-hand corner of the balance sheet should show a plus figure.

 ¨       TEN FINANCIAL STATEMENT WARNING SIGNS.

1.      Excessive (or nil) management fees.  Why or why not?

2.      Excessive professional fees.  Why or why not?

3.      Excessive bad debts.  Why?  Bad credit policy?

4.      Loans to shareholders.  Why?  Can they be paid off or ignored?

5.      Off balance sheet financing.  Note buildings or vehicles owned by management.

6.      History of losses.  Why?

7.      Is there an excessive overhead cost?  Why?

8.      Does management have inferior ability?

9.      What credit facilities does the company have?

 10. Cash flow.  ‘When all else fails -- read the directions.’  

Chris Wilkinson.                              

Certified Business Behaviour & Attitudes Analyst.               

Business Coach.

Tel: (905) 275-2907 (Mississauga).

E-mail: buspilot@bell.net