Your company’s financial reports provide the basis for a great deal of decision making. You want to be sure that they enlighten rather than confuse! Here are five of the most common things that make financial reports confusing:
1. Poor formatting – Just pushing a button in QuickBooks and spitting out a report often doesn’t cut it. Taking a few minutes to spruce up the formatting can make a big difference in a report’s usability.
Beyond the “look and feel” of the document, though, poor formatting can also be a matter of inconsistencies in the data that’s being formatted, or data presented in an illogical order. For example, I’ve seen Income Statements that listed “labor” in six different places—none of which were at the top of the list, even though labor was the organization’s number one cost.
2. No narrative or context – Chances are slim that everyone who reads the report will be able to instantly discern what the data is communicating. It is helpful to point out the key issues, and possibly provide a conclusion or suggestions for improvement. In many cases it is also a good idea to include historical or industry data, to give context to the data being presented.
3. Undefined acronyms – When sharing financial information it’s important to speak English and not “accountant-ese.” Don’t assume everyone reading the report knows what “Cap Ex” or “EBITA” is.
4. Too much detail – In large companies it is common for the Income Statement to have 50 or more potential line items. Obviously, the report can get confusing if all 50 are included. It’s just too much detail! In cases like this, see if you can consolidate things on the main report, and then provide the ability to drill down into the details as needed.
5. Not tailored to the audience – Think about who the report is for, and customize it accordingly. Your rank and file employees, for instance, will be interested in different data than your investors and bankers, who may have different data needs than your executive team.
The bottom line is, if you’re going to do the work to gather and analyze the data, put in the extra 10% more time to polish the report. Confusing reports do not benefit anyone.
Need help creating financial reports that are a pleasure to use? Give me a call. As your part-time CFO, this is one of the many services I provide.
Whether your company is in growth mode or trying to deal with flat or diminishing sales, there’s a good chance you depend on credit from your bank to help you pay the bills. Which is why I’m always surprised to see how many companies do things that ruin their banking relationship!
Bankers are generally very cautious people. They need to feel completely confident that the money they loan to you will indeed be paid back. Do one of the following actions, and run the risk ruining your banking relationship:
• Provide misinformation or no information. The quickest way to lose your credit is to surprise your bankers. The worst way is to lie to them. If your company is struggling, the best time to tell your banker that there’s a problem is as soon as you become aware of it.
• Add to your debt. In most cases, borrowing money from other sources (outside of trade payables) without your banker’s approval or consent will violate your loan covenants.
• Break the law. Your banker will not be happy if you incur a significant regulatory violation by failing to comply with a law, such as not reporting or properly resolving a hazardous spill, or getting slapped with a class action lawsuit because you didn’t comply with labor laws.
• Miss your previously reported earnings projections. Say your bank has raised a concern about your repeated failure to hit your leverage ratio, and you have assured them that this quarter you’ll hit the numbers. If you don’t, they might get “lender’s fatigue” and give up on you.
• Use corporate assets to buy luxury items. If your banker sees that, while you’re seeking to continue to expand your loan base, you’re using corporate funds to buy luxury boats, planes or cars, they’ll think twice about approving another loan.
• Miss reporting deadlines. It is vitally important that you provide accurate and timely financial statements, and be proactive about telling your banker if something is amiss.Most of the things on this list are typically covenant violations. Always keep in mind that your banker has the right to call your loan—and demand immediate payment—for any covenant violation, regardless of its magnitude. When that happens, I can tell you that it’s really not a pleasant position to be in.
Need help proactively managing your banking relationship? Give me a call. As your part-time CFO, this is one of the things I can do for you.
It’s a fact: Lenders only fund loans when they’re comfortable that they’ll be able to collect both the principal they lend and the interest they charge. The degree of comfort they feel dictates how much they’ll lend and the interest rate they’ll charge. Your loan package must convince them that your request meets their criteria. Which is why getting it right is so crucial!
The Key Elements of a Successful Loan Package
If you can provide the following items in a way that will make the lender agree the loan makes sense, you’ll be able to secure the loan at a reasonable interest rate, with payment terms and loan covenants that you can safely satisfy. But if you’re missing any of these elements, or if they don’t point to your ability to repay the loan, then you’re not likely to have much luck obtaining funding at all.
• Business plan & projected financials – You can help yourself get the best loan by having a solid business plan that forecasts revenue and expenses for the desired loan period. This plan must show where your company has been and where it is going in terms of sales growth, business opportunities and more.
Your projected Profit & Loss Statement, Balance Sheet and Statement of Cash Flow provide the numbers that support your plan. Each of these financial statements should be presented on a quarterly basis for each quarter of the desired loan period.
• Current financials – In addition to the projections, lenders also want to see your current year’s financials, which serve as a benchmark.
• Narrative – Your loan package must clearly show why you need the money, and when and how it will be paid back. While the numbers should do much of the “talking,” if you don’t already have a relationship with the lender it’s best to include a page or two that lays out the assumptions and provides a top-level view of your company and plans.
• Extra explanations – In addition, be sure to provide more information for anything that might be a potential red flag. For example, if you’re projecting 25% revenue growth in an industry that’s flat, you need to explain how you will make this happen.
Need help with any of this? With over 30 years of experience, I know what lenders are looking for when they’re considering loaning money to companies like yours. Give me a call. As your part-time CFO, I’m here for you!
This is the third and final installment in my series on how to review your year-end financial statements like a seasoned pro. So far we’ve looked at your Statement of Cash Flow and your Income Statement. Now it’s time to examine your other key financial statement, your Balance Sheet.
Your Balance Sheet provides a snapshot of your business’ financial condition at a specific moment in time – in this case, your fiscal year-end. It shows your firm’s assets, liabilities and owners’ or stockholders’ equity.
Compare to Last Year
Just like when evaluating your Income Statement, your starting point in understanding the picture that your Balance Sheet is painting about your business is to compare it to the prior year. Take a close look at:
• Cash – Did cash go up or down? Do the numbers match what’s on your Statement of Cash Flows? If not, an accounting error has been made somewhere…most likely in the Statement of Cash Flows, which can be tricky to compile.
• Working Capital – Working capital is your current assets minus your current liabilities. Is it positive or negative? Did it increase or decrease as compared to last year?
Look at Important Ratios
Next there are two important ratios that you should review:
• Current Ratio – The Current Ratio is the ratio of current assets to current liabilities. This provides an indication of your company’s liquidity and ability to pay back its liabilities.
Ideally, the Current Ratio will be stronger than 2:1. A ratio of 1:1 indicates that your company barely has the ability to meet its anticipated debts for the next 12 months. A ratio of less than 1:1 is usually a sign that your company is not in good financial health.
• Leverage Ratio – The “Leverage Ratio” is the ratio of debt to equity. Banks look at this ratio when deciding whether or not to approve a loan.
A ratio of 4:1 or above is considered highly leveraged.
A ratio of 2:1 or less is ideal. This indicates that your company has the ability to safely borrow additional debt.
A ratio of 2.5:1 or 3:1 is in the upper limits of most banks’ “safe zone.” Borrowing money at this point is possible but more difficult.
If you’ve been following this series you now know the secrets to evaluating your year-end financial statements. Of course, if you need any help with any of this, give me a call. As your part-time CFO, I’m here for you.
In my last article I discussed how to review your Statement of Cash Flows. Today we’ll look at your Income Statement, also known as your Profit & Loss (P&L) Statement. Then, in the final article in this series, I’ll explain how to evaluate your year-end Balance Sheet.
Of course, these tips apply whether you’re reviewing your own company’s financial statements or you’re looking at another company’s information – such as the financial statements for a customer that has applied for credit.
Comparisons Can Be Very Helpful
A good starting point is to compare the year-end Income Statement to that of the prior year. If you’re reviewing your own company’s financials, you should also compare it to budget.
Here are some of the first things you should look at:
• Is the revenue going up or down?
• Are the gross profit margins increasing, decreasing or flat?
• Are operating expenses moving as you would expect based on the changes in revenue?
• How did actual performance compare with the budget forecast?
Understand What Happened During the Year
Reviewing an Income Statement is not just a matter of seeing if the numbers look “about right” and moving on. You also need to ask questions to understand what happened during that time period. These include:
• What’s driving the change (or lack of change) in gross profit margins?
• If operating expenses are not moving in tandem with revenue, why not? If expenses are rapidly accelerating, what’s driving it? If cost-cutting measures slashed expenses, how are these measures affecting operations?
• Were there any unusual or non-recurring expenses? How would the Income Statement look if you pulled the one-time expenses out of the picture?
Be Sure to Look Forward, Too
Next you want to ask about how the events of the past year will likely impact the company going forward. For example:
• Is it anticipated that the current levels of revenues, operating expenses and gross profits will continue in each of the next four quarters? Why or why not?
• Are the needed credit facilities in place to support operations and/or anticipated growth? As I have discussed in the past, you need to avoid growing yourself out of business."
• How are vendor relations? Are there any potential supply issues that could affect operations?
I also like to ask divisional managers what two things could be changed in company operations to increase bottom-line profit. The answers can be very revealing!
When I meet with small business owners, it often becomes clear that they are mystified by their business’ financial statements. Unfortunately, because they don’t know what to look for when evaluating these essential documents, they miss out on both red flags and opportunities.
This is the first of a 3-part series on how to conduct a review of your year-end financial statements. In future articles I’ll discuss the other two parts of a quality set of financial statements: your Balance Sheet and Income Statement (also known as a “P&L” or Profit & Loss Statement).
Cash is King
Because cash is so important, the Statement of Cash Flows is the first thing you should look at when conducting a year-end financial review. After all, when it comes to running and expanding a business, cash (or, more specifically, cash flow) truly is king.
Your Statement of Cash Flows helps answer some vital questions. Does your organization have enough cash to stay in business? Is it generating more cash than it’s using – or vice versa? Would it qualify for a bank loan? And more.
Start with the Details
Your starting point should be to ask some important questions about the details:
• How was cash generated by and used in operations? For example, have your collections of trade receivables sped up or slowed down?
• How was cash generated by and used in investing activities? For example, did the company buy or sell property and/or equipment?
• How was cash generated by and used in financing activities? Did the company obtain cash through borrowing? Did it use cash to pay down lines of credit or other long-term debt?
Then Look at the Big Picture
Next look at everything as a whole. Identify any non-cash expenses on your Statement of Cash Flows, such as amortization and depreciation. Add these back to your net income to help you get an accurate picture of your actual cash flow.
Compare cash at the beginning of the period to cash at the end of the period to see if your company is generating positive cash flow. Although there are some exceptions to the rule (such as start-up companies that have received an infusion of cash), generally speaking if your company is generating positive cash flow then it is profitable. Which, of course, is what you’re hoping to see.