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Tuesday, September 12, 2006

What your financial statements tell you

As an entrepreneur, one of the things you need to learn is how to analyze your financial statements.

Understanding financial statements is critically important to the success of a small business especially during its first two years. .

Financial statements can be used as a roadmap on your business journey to economic success. Using numbers as navigation aids can steer you in the right direction and help you avoid costly mistakes. Most entrepreneurs don’t realize that financial statements have a value that goes far beyond their use to prepare tax returns or loan applications.

First, ask your accountant to derive the following financial information from the balance sheet and income statement:

1) Sales Growth on a monthly basis
2) Gross Margins as a percentage of Sales
3) Net Operating Expenses as a percentage of Sales
4) Accounts Receivables (Days)
5) Inventory (Days)
6) Accounts Payables (Days)

The first three data are what we call the Growth and Fundamental Profitability Indicators of an enterprise. These are critical factors that determine whether the business can generate enough cash to be sustainable in the long-term.

The second set of data (Account Receivables Days, Inventory Days and Accounts Payable Days) is called the Swing Factors. They are called swing factors because any small improvement or decline in any of the three variables can result in a significant shift or swing to the cash position of the company.

Now, what’s the implication or importance of this financial information to your operations? First, the analysis of your monthly (annual) sales growth will reveal whether the business is generating enough cash. It is worth noting that any changes in monthly/annual sales will impact on your monthly/annual cash flow. Sales growth is an indication that your business is using a large amount of cash to finance any business growth.

As an entrepreneur, you know that sales is a function of the selling price and the quantity sold. Manipulate these two critical variables to achieve your desired sales level.

source: SME.com.ph

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