Many business operators, regardless of background, are charged with some degree of fiscal oversight. While some may have a basic understanding of the information listed on their company’s financial statements, the majority are not accountants, nor have they had training that covers the detail contained within their financial statements.
Financial statements, which include the balance sheet, income statement, and statement of cash flows, are the most important sources of financial information one must understand if they wish to fully grasp the fiscal health of their company. The balance sheet and income statement provide a wealth of crucial information that can indicate how well or poorly a business is doing, overall. In this article, we will examine gross profit and accounts receivable.
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Analyzing year-over-year data is often the most effective means of comparing certain types of performance indicators. Let us first look at gross profit margin. This particular item, expressed as a percentage, will reflect the degree of gross profit realized on a sale of merchandise after factoring in the cost of goods sold associated with generating each dollar of revenue.
Look at the following example: A product is sold for $50 at a gross profit margin of 30%. In this case, the gross profit generated by each unit sold will be $15. Many business owners come to understand how the gross profit margin in their business historically functions and intuitively knows the impact a change in their business strategy will likely have on both their gross profit and net income.
Let’s move on to the Balance Sheet. When a company’s CPA analyzes its financial statements, one thing he or she will typically look at is a history of the accounts receivable (money owed the company by its customers) over the past several years. Normally, if accounts receivable have increased three years in a row, one would conclude that this is a direct result of a proportional increase in sales.
However, what if, during that time, sales have decreased? Where accounts receivable have increased and sales have decreased, there is likely a problem with the company’s collection process. The business owner should determine if and why customers are behind in payments. Questions to ask include whether one’s company billings are timely or if their collection process could be more effective. Accounts receivable and sales are directly linked and tend to fluctuate at the same rate of change over time in the absence of other influences.
While this article only touches upon a few pieces of information included in the financial statements, it is beneficial for a user of those financial statements to understand how a company came to these figures when assessing that company’s financial health.
Analyzing and understanding financial statements can be confusing—and we can help. If you have questions about your financial statements, how to analyze them, or how to improve your business operations based on the information in the financial statements, contact me at [email protected] or any of our accounting professionals at 216.831.0733. We’re happy to help and ready to start the conversation.