Overview
In April, as Q1 business results are being finalized and reviewed, it is a good time to evaluate if the company is tracking the key information and results of the business. This topic is a high-level overview of how financial statements work and interact, and why having a dashboard is important to interpreting performance. While good recordkeeping is important, it is also important to organize financials in a way to run and manage the business.
Preliminary Note: Cash vs. Accrual Accounting
Most companies track financial activity in an accrual basis. This is important because tracking activity on a cash basis gives business managers a very narrow and often inaccurate picture of business activity. Cash basis provides numbers based on the cash in hand at this moment. Accrual basis includes accounts receivable (invoices billed but not yet paid) and accounts payable (bills not yet paid) for this time period. Consequently, accrual accounting tracks numbers when they are billed or expenses, not just when they are collected or paid.
Financial Statements
The three financial statements that private companies should use on a monthly basis are:
Income Statement
Balance Sheet
Cash Flow Statement
1.Income Statement = Profit & Loss Statement
Total Revenue
- Cost of Goods Sold
= Gross Profit Margins
- Operating Expenses
= Operating Income (= profits before owner expenses)
- Owner Expenses
= Net Income (aka the bottom line)
It is useful to review the income statement current month against Budget, Prior Month Actual, and Prior Year actual. This can be tracked in a dashboard.
2. Balance Sheet
Shows the company’s financial position at a specific point in time. Includes Assets, Liabilities, and Owner’s Equity.
Assets are listed in this order:
Current Assets (most often, cash, accounts receivable, and inventory)
Long-Term Assets (includes equipment, facilities, and intellectual property)
Liabilities are listed in this order:
Current Liabilities (need to be repaid within 12 months, such as accounts payable, short-term loans)
Long-Term Liabilities (long-term loans such as mortgages)
Equity: The difference between all assets and liabilities. Equity includes all undistributed profits.
Total Liabilities plus Owner’s Equity must equal Total Assets in order for this financial statement to be in balance.
Calculate and track in a dashboard:
Working Capital = Current Assets – Current Liabilities
Current Ratio = Current Assets / Current Liabilities
3. Cash Flow Statement
Shows actual flow of cash in and out of the company during a given period (cash as opposed to accrual). In an accrual system, the cash flow statement ties the accrual income statement to actual cash that flowed in and out of the business. The adjustments highlighted in the cash flow statement also tie back to the balance sheet.
Has 3 sections: Cash from Operating Activities, Cash from Investing Activities, and Cash from Financing Activities
Cash from Operating Activities:
Net Income (should match Net Income from Income Statement)
+ Adjustments, which show changes in Accounts Receivable and Accounts Payable and Inventory
= Net Cash from Operating Activities
Cash from Investing Activities:
Cash collection and payment from the purchase and sale of long-term assets
Cash from Financing Activities:
Cash received and paid from borrowing on and paying down loans
Adding these three plus the cash at the beginning of the period gives us the cash at the end of the period:
Net Cash from Operating Activities
+ Net Cash from Investing Activities
+ Net Cash from Financing Activities
+ Cash at beginning of period
= Cash at end of period
Financial Statement Check
Does the balance sheet balance? Total Assets should equal Total Liabilities & Owner’s Equity.
Does the Net Income from the Income Statement start and match the Net Income on the Cash Flow Statement?
Does Cash from the Beginning Balance Sheet match the Beginning Cash Balance on the Cash Flow Statement?
Does Cash from the Ending Balance Sheet match the Ending Cash Balance on the Cash Flow Statement?
Dashboards
In addition to financial statements, dashboards are helpful for the following reasons:
Dashboards track information that is not tracked in financial statements.
Dashboards track financial information that is essential to the business model.
Dashboards track key performance indicators associated with strategic initiatives.
1. Dashboards track information that is not tracked in financial statements.
Having a dashboard is helpful in revealing correlations between customers, revenue, and cost of goods sold as an indicator of business health. Utilization and realization are also helpful to track using dashboards for both individual employees and across the firm. See the March Monthly Topic for more on utilization and realization.
2. Dashboards track financial information that is essential to the business model.
A sign of a healthy company is that its spending categories are proportionally appropriate. The target business model is generally to spend 40-45% on employees (payroll, benefits); 10-20% on overhead costs, and 35-50% on owners (NOI – Net Operating Income).
3. Dashboards track key performance indicators associated with strategic initiatives.
Some of the key performance indicators that are useful to track are diversification of geography, productivity per employee (utilization), customer growth segments, new service growth segments, and customer longevity. It’s also helpful to compare these with others within the industry.
Summary
Using these financial statements on a monthly basis, as well as comparing them to previous trends, will help the company assess its financial position and plan for the future. Meanwhile, companies should also choose and design their specific dashboards so as to reflect the business’s particular focuses, but it is also good to keep some of them general enough to be comparable to industry averages. Companies that generate and regularly review a set of strategic dashboards are able to see trends in their growth and performance over time.
Don't hesitate to reach out to us for copies of prior editions from our extensive Monthly Topic archive. Other April Financial Systems Monthly Topics include: ERPs (Enterprise Resource Planning), Dashboards Focus, Financial Systems Focus.
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