Today, i will discuss about financial statements and How to Read Financial Statements. This is an example, I have already kind of discuss about what the different financial statements. Today we’re going to be covering the balance sheet the income statement and the statement of cash flows. As we go through them and I’m going to show you kind of what I’m looking for what things might be red flags and what key metrics you should be checking out as you’re going through the financial statements.
How to Read Financial Statements
So let’s get started with the balance sheet okay so the balance sheet is a listing of everything that you own. You’ve got your assets at the top you’ve got your liabilities at the bottom and then you’ve got equity under that equity is basically the value of your company. You take your assets you take you subtract out your liabilities and you are left with what the company is worth now. What it’s worth on a cost basis it’s not the same as maybe you could get out in the free market but it can give you kind of a sense of whether your company has value or not. So when you’re looking at this you’re going to be checking out.
Checking Balance Sheet
The first thing I would do when you’re checking out the balance sheet is to make sure that the numbers make sense. So when I look at the balance that’s in the checking account. I want to make sure it matches against the reconciliation. I did against about against the actual bank. I’m going to take a look at accounts receivable. I will pull up an aged receivable just to kind of take a look see the number. Here is 29 85 and the number here is 2985. This tells you exactly what’s on the balance sheet and if there’s something on here. You don’t think you’re going to be able to collect. You need to write that sucker off because otherwise this number really doesn’t represent the truth. You always want your numbers to represent the truth. So you’re just going to go through and see if there’s a way to verify each and every number.
I’m looking at this I’m kind of raising my eyebrow at the computer equipment number. It’s a big negative number and you can’t have negative computer equipment. So I would just open up the detail of this hold down control click on it. It’ll open a new tab for you and it gives you the details of what that is it looks like? There was a journal entry with that was recorded. I argue that this number isn’t right because it’s taking out more than it’s supposed. So I would definitely look into that and fix it. If you can and then just go through all of these the other thing that I would raise an eyebrow to is historical adjustment. There really shouldn’t be any historical adjustments. If you’re keeping up with your books and things are nice and clean in this case. I took a look and it it showed up when they converted the file from a different software type to here. They didn’t know what it related to and they just booked it here. I would say that needs to come off as well maybe at the end of the year maybe at the end of the month whatever makes sense for your business. If you can’t identify it you might need to amend a prior your tax return or whatever. So that’s something else that I would kind of take a look at but the rest of it. If it looks good then here are the things that you should pay attention to when you’re looking at your balance sheet the first thing is your equity. You want to make sure that the value of your business is growing over time and the way that that happens is by checking out the trend of the equity.
So if you’re looking at it you’re like four thousand forty two hundred fifty two hundred. It’s going up that’s a nice no that’s not good. Now it’s tanking you’re going to a want to check out. What happened in the last couple of months that made your current year or your current year earnings balance plummet. So your year-to-date in July was a net loss of forty eight hundred your net loss in August is almost 13,000.
We’ll go take a look at the income statement a minute. What’s going on with that but the fact that this is going down should tell you as a business owner that something might be wrong that you might need to fix as the business owner. The other thing you want to take a look at super important anything that is a current asset. So your bank balance plus any current assets like accounts receivable anything. You’re collecting within the next year you want to make sure, you want to take the total of that so about what $4,500 that to your current liabilities. Which is 17,500 you have about $4,500 to cover about 17,500 dollars worth of expenses of liabilities.
The next year that should be concerning to you as a business owner you really want that ratio to be at least one to one better yet if you can make it two to one all right because this tells me that you’re probably going to run out of cash before these liabilities. So that should concern you as well by the way the current assets divided by current liabilities is called the current ratio. So if people discuss about that now you know.
Now let’s hope on over to the income statement the income statement is a whole bunch of basic math. You’ve got your sales that come in you subtract out the cost of your goods sold you subtract out all your other expenses. What’s left over is your profit? So when they discuss about the top line they’re discuss about the sales that you made they’re discuss about the bottom line. They’re discuss about your net profit or net income. So when you’re looking at this it’s going to be a little bit of a gut check a lot of people especially ecommerce sellers, who are selling on Amazon or Shopify or something they have a sense of what the sales should be for the year. If those don’t reflect what your expectations are you should drill down and find out why not you might be missing something.
About Gross Profit
Now, I will take you to your gross profit and then all the rest is just the expenses of running the business the stuff that you care about. I’d say the two most important numbers on. Here when you’re looking at the trends is going to be your sales and the trends just basically how it’s going. So it kind of is hobbling around and then it goes up and then it goes down again and then it goes up and up this this increase towards the bottom or towards the most recent months that’s good you want see your sales increasing over time as you might expect.
Now you want to make sure that your net income is increasing kind of parallel to your sales. You will have both of those numbers kind of going up at the same time. When you’re looking at this you’ll see they don’t actually it kind of gets worse at the same time that the top sales are getting better. So you want to look at these numbers and go.
Why is that there was a huge increase in advertising. Which I would be concerned maybe this will pay dividends maybe down the road. You know for an increase of what twenty five hundred dollars roughly of sales actually not even to spend $8,000 in advertising not a great return on your investment. So you need to tweak that a little bit consulting and accounting. It is what it is you want to make sure though that that you’re getting big bang for your buck on any of these big expenses. You’ve got I would also check out anything that looks.
Here’s the culprit down, here it’s the wages and salaries. So you’ve got like nine thousand dollars now per month in wages but that’s just barely less than what you’re actually bringing it in sales and that’s what’s accounting for this huge loss that you’ve got going on. So you might need to restructure and figure out. How to keep your business profitable maybe with this huge advertising and the extra manpower maybe in September.
You’ll see all of this turn around but these are things that you want to pay attention to and keep your eye on when you’re looking at your financials but mostly. You just want to see look at the trends look and see do the numbers make sense. If you see a particularly big number and it doesn’t feel right. Why did I don’t remember spending $4,500 ctrl and click and you can get the details. I know what I was doing okay makes sense.
Cash flows Statement
Let’s move on to statement of cash flows for statement of cash flows. It actually has three different sections operating activities investing activities and financing activities it looks like. This company didn’t use any financing. So it’s not included on there. If you have if you’ve taken out a loan. You don’t see financing activities on your statement of cash flows that should be a big red flag this your financing your business. Somehow that should be separated out. The number the big number that you care about on this report is the operating activities the net cash flows from operating activities you’re looking at this number. Here you want it to be positive you want positive cash flow. If your business the regular operations of your business is not generating enough cash to stay positive. You’re going to have some problems down the road because chances are you are filling in that gap other ways. You’re using credit cards you’re using. You take out a loan or something like that and that can mask the problem that you’re having unless you’re looking at your statement of cash flows.
So when you look at your statement of cash flows this number really needs to be positive. If it’s important to your business to invest in something like equipment for your business you want to make sure that this is positive enough just not only to cover basic operations. I also to cover any additional influxes of cash that you’re going to need for investing in equipment for your business to help keep it healthy. So the higher your net cash flows from operating activities the healthier your business is going to be. If you’re just getting started make sure you check out our e-commerce startup guide. It will give you lots of helpful information about how to avoid some pitfalls and get started with your online retail business.