What Best Practices should you follow when conducting a Financial Review to ensure your decision-making is based on a thorough understanding of your business? This article provides pointers to help you get the most out of your Financial Statements.
Traditional financial statements, like the Balance Sheet, Profit & Loss, and Income Statement have been around a long time. They must be working well! That’s true… but like any presentation of data, it’s INTERPRETATION which makes the data valuable. In this case, “value” means helping leaders make the best business decisions.
Let’s look at some Best Practices when reviewing your financial statements.
The Importance of Review
Get out of your mind that Financial Review is just a necessary chore. On the contrary, it is an extremely important activity which requires FOCUS. It is a time to work “on your business” and, with that attitude, you’ll get a lot more out of it.
Frequency of Review
This will depend on the business. For some, monthly may be too often. For others, quarterly may not be often enough. Typically, the more frequently you review the financial statements, the less time the review should take.
Review Financial Statements based on Business Goals
If revenue growth is the main goal, expense reduction is less important. If growing enterprise value is the main goal, revenue trends may be less important. Structure your analysis of financial statements around what you are trying to achieve in the business and focus on those areas. Remember, goals change over time so should be revisited periodically.
Business Goals and Owner Goals
For many small businesses, business and owner goals may be identical. But things can get complex where, say, there are two owners and one is planning to retire soon and sell his shares while the other is committed to long-term business growth. These owners may be looking for different outcomes from the business including financial outcomes.
What is going to Change?
Financial statements paint a picture about the past. Leaders may already have made decisions which will fundamentally change business performance, e.g. capital expenditures, new products launches, mergers & acquisitions, downsizing, opening or closing offices, key hires etc. This may make analysis of SOME historical data irrelevant. Best to focus on the ROI of these future investments.
What to Review
There are so many options… but a good starting point is the performance of the previous month and year-to-date. Next would be to compare this to what was expected (the forecast) and to look at any variance from last year over the same period.
What is changing in your business over time? Maybe revenue is growing at a lesser rate in the past 12 months than in the previous two years. But profitability is increasing over the same period. This will only be revealed by looking at longer-term trends. It is helpful to isolate a couple of metrics you want to track. Presenting trends graphically is helpful.
Cash flow can never be ignored. Even cash-rich businesses should keep an eye on this and understand how they will fund operations going forward.
Cutting costs is one way to access more cash but there are often opportunities in ‘Aged Accounts Receivables’. Poor collections processes prevent access to cash which has already been earned.
A reality of business is paying taxes. Understanding your obligations (and how you’ll meet them) and the impact to your cash flow can reduce the burden of worrying about tax. Of course, this leads to a discussion on tax mitigation strategy.
Compliance with Contracts
Financial statements present one aspect of the business but they don’t necessarily capture ALL consequences of business decisions. Example: The financial statements reveal that rental costs are way too high and are negatively impacting the business. A purely ‘financial’ decision would be to cancel those rental contracts… but that may not make sense where cancellation terms impose penalties on your business. Consider ALL the implications of business decisions.
Human Resource Concerns
Businesses are made up of people. A business may have the best products in a great market with limited competition… but if the people are not productive or cannot collaborate, value will not be created. The Financial Statements can give clues on general staffing concerns, employee turnover, retention, recruitment and/or training costs, litigation etc.
Are the current compensation structures working? Are the incentive plans actually incentivising employees to be more productive or remain with the business? Financial Statements provide guidance on this.
Every business will – at some stage – go through a ‘succession event’, that is, a change of (complete or partial) ownership. It may feel like a long way off but many leaders ignore this until they can’t properly control the process and they don’t get the best outcomes for the business or the owners. Financial Statements provide one data point as to the value of a business and this may warrant discussion from time to time.
It is impractical to try and discuss all of these issues at every finance review. Much more sensible is to consider the highly strategic, long-term discussions on an annual or semi-annual basis. The more frequent reviews should look at tactical questions and ensure you are on track to achieve the strategic goals. A business in distress will need to be hypersensitive to their predicament which requires a flexible approach with quick action. Like all business meetings, a financial review should generate “WHAT, WHO, WHENS” – a list of actions to be taken to improve the business.
Again, each business is different so you should implement the Best Practices that make sense to you. And please get in touch to improve your understanding of your Financial Statements and enable the best possible decision-making for your business!