Financial reporting looking at the past, present and future
Financial information comes in three tenses – the past, present, and future. Each have their own usefulness but while the past is the most common measure of a business, the present and future allow for real action and impact on your business.
The Past - P&L and Balance Sheet
Understanding your monthly and year-to-date financial results - a P&L (1) and Balance Sheet (2) - is crucial. They are a measure of the decisions you’ve made, what worked, what didn’t and where you stand against your goals. Specifically on the P&L (or income statement) you want to understand which products or services are selling well and where you are spending most of your costs. If your revenue is below your costs, you should consider whether you charge enough or how efficient your business processes are. Your balance sheet reflects what you have (assets) and what you owe (liabilities) and what’s left over (retained earnings).
The Present - Current Ratio
For a small business owner, having cash in the bank to pay employees and vendors is an ongoing preoccupation. The cash balance only tells part of the story. We like the current ratio for understanding the whole picture. Current ratio (3) is a measure of how well you are set up to manage your upcoming payments. It’s the ratio of current assets (cash and accounts receivable) to current liabilities (vendor payables, interest etc.). The higher this ratio is, the more assets you have available to you to pay for your upcoming liabilities. A ratio of 1.5 – 2 is considered healthy.
The Future - Financial Forecast and Cash Flow Forecast
Understanding the future allows you to influence it. The Financial Forecast (4) has two parts – revenue and costs. As a result, this provides us with the forecasted net income.
Revenue forecasting is a mix of art and science and must walk the tight rope of being realistic without being overly optimistic or overly pessimistic. Ideally you can list all potential revenue sources – products and/or services by client or business line and assign an amount of revenue to each and its likelihood of occurring and when (ideally month or quarter). Cost forecasting tends to be more predictable but always consider the impact of increasing revenue on the expenses you need to incur to service it (for example, employees). A sound forecast points to the actions you need to take to influence your future – more business development activities in Q3? More resources given the influx of work in Q4?
The Cash Flow Forecast (5) is another useful tool. This helps to understand and influence the future. Start with your current cash balance, predict your receipts and payments for the coming months (leveraging your financial forecast) and you’ll start to understand when you may need additional capital for your business or have excess for that next employee.
What it Comes Down To
Running a business boils down to a series of decisions involving money. Understanding the past, present and future tenses of your financial status will help you make good decisions. If you need some support with reporting and decision making, we can help! Get in touch with us.
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(Photo description: Close up of financial reports with hand holding pen over the reports.)