Your time is precious.
To succeed in business, you must make smart decisions about using your time, and that includes the time you spend on financial analysis. While many owners review the balance sheet and income statement, many managers ignore other data that can help them make informed financial decisions.
Here are seven commonly ignored financial reports that may help you manage your business more effectively.
Multi-Step Income Statement
A multi-step income statement separates income into operating and non-operating categories, and this information helps you understand what activities are driving company profit. When you generate an income statement for review, use a multi-step format.
Assume, for example, that you own Tailwind Bikes, a bicycle manufacturer. Here is the multi-step income statement for March:
|Income Statement for the period ending March 31, 2018|
|Cost of sales||-800,000|
|Home office costs||40,000|
|Total Operating Expenses||-150,000|
|Gain on sale of machine||1,500|
|Total Non-Operating Income||4,500|
As you can see, most of your business activity flows through gross profit:
$1,000,000 sales – $800,000 cost of goods sold = $200,000 gross profit
The materials, labor and overhead costs you incur to make bicycles are posted to cost of goods sold. In March, you sold $1,000,000 in bicycles, and the units you sold had a total cost of $800,000.
You incurred other expenses to operate your business in March, such as advertising costs, commissions paid to salespeople, and the cost to operate your home office. Operating expenses are subtracted from gross profit to calculate operating income:
$200,000 gross profit – $150,000 operating expenses = $50,000 operating income
Operating income vs. non-operating income
Operating income is generated from the day-to-day activities of running your business. In March, bicycle sales produced $50,000 of operating income, and your company also earned non-operating income, including $3,000 in interest income and a $1,500 gain from the sale of a machine.
$50,000 operating income + $4,500 non-operating income = $54,500 net income
Your business must be able to produce the vast majority of net income from operating income activities because operating income is sustainable. Non-operating income is not consistent or predictable, and no company can survive over the long-term by relying on non-operating income to produce annual profits.
Use a multi-step income statement, so that you can see that amount of profit that is generated from non-operating income.
Profit margin & sales mix
Use the data in the income statement to generate a report on profit margin and sales mix. Each product may have a different profit margin (profit/sales), and a business can change the sales mix of products to generate a higher overall profit.
Assume that the hardware store earns $4 on a garden hose priced at $20, and $45 on a $300 lawn mower. The profit margin on the garden hose is ($4 / $20), or 20%, while the lawn mower profit margin is only 15% ($45 / $300). The lawn mower generates far more revenue, but less profit per dollar of sales. The hardware store can increase the company-wide profit margin by selling more garden hoses and fewer lawn mowers.
Take the time to analyze your firm’s sales mix.
(Do you know how sales taxes are impacting your bottom line? Find out with our handy sales tax calculator.)
What about debt?
If you carry debt in your business, you may only think about making your monthly payments. However, a growing amount of debt can limit your financial options.
If a firm doesn’t monitor the amount of debt borrowed over time, repaying the debt may become difficult, so use your accounting software to run a report listing the debt to equity ratio.
The formula, (total debt) / (company equity), is used to analyze debt as a percentage of total equity. Let’s assume that a typical ratio for companies in your industry is 2-to-1, or $2 in debt for every $1 of equity issued. If your firm’s ratio climbs to 3-to-1 or 5-to-1, it may be a red flag that your total level of debt is not manageable.
If your debt to equity ratio is increasing, take steps to reduce your debt load. Review your business plan, and cut expenses so that you can pay down your debt faster. Don’t let a large amount of debt limit your ability to grow the business.
Many business owners don’t plan for the replacement of assets used in the business, and this mistake can have a huge impact on your company. You can’t operate without fixed assets, and you need a plan to replace them over time.
The owner of the pizza restaurant, for example, should review the list of fixed assets, the remaining useful life of each asset, and how much depreciation expense has been recorded. For example, if a $10,000 pizza oven has two years of useful life remaining, the owner must plan to pay cash, or take out a loan to replace the asset, in two years.
If you don’t review the fixed asset listing, you may not be able to replace assets and keep your business operating.
A retailer can’t sell a product if it’s not in inventory.
Many businesses don’t carefully plan for inventory purchases, and these firms risk the loss of a sale if inventory levels are too low. Every company should plan for an ending balance in inventory at month end, which allows the business to fill customer orders in the first few days of the next month.
For formula for ending inventory is: (beginning inventory + purchases – sales = ending inventory), and ending inventory is often based on a percentage of monthly sales. Use accounting software to create a customized report with this information.
Assume, for example, that the hardware store’s beginning inventory balance of lawn mowers is 50 units, and that the company forecasts 300 mower sales for the month. If the business wants 30 mowers (10% of expected sales) in ending inventory, the number of mowers purchased should be (300 projected sales + 30 ending inventory – 50 beginning inventory = 280 purchased).
Use an inventory formula report to ensure that you maintain a sufficient amount of inventory for each product that you sell.
No business can operate without sufficient cash inflows each month, and many firms do a poor job of forecasting expected cash flows. Here are several factors that impact the amount of cash a company will have to operate:
- Accounts receivable: The dollar amount of credit sales that are not collected in cash, and the average amount of time it takes to collect the receivables in cash.
- Inventory: The dollar amount of inventory needed to fill customer orders over the next several months.
- Debt payments: Interest payments and any repayments of principal due in the next few months.
These factors help to determine the amount of cash required to operate. If cash inflows are insufficient, the firm may have to access a line of credit or raise more capital through a stock or bond offering.
Create a customized report to project your cash flow for each new month.
Are you getting paid?
Firms that don’t closely monitor accounts receivable and enforce a formal collection policy may not generate sufficient cash inflows to operate.
Your accounting software should provide an aging schedule for accounts receivable, which groups your receivables based on when each invoice was issued. You should monitor this report and implement a collections process to email and possibly call clients to ask for payment.
Cost vs. benefits
Now, there’s no question that reviewing each of these reports will require more time, but the benefits justify the time investment. Using these reports can help you reduce costs, increase sales, and maintain a sufficient cash balance. Invest the time needed to generate and review these reports.
This article originally appeared on the QuickBooks Resource Center and was syndicated by MediaFeed.org.
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