Financial Statement Analysis To Increase Profitability
"It is better to know some of the questions than all of the answers." James Thurber
Traditional financial statement analysis takes more of an outside-in approach where an accountant or CPA applies various techniques to discover the profitability, solvency, liquidity and stability of a business. Usually the objectives of the analysis are for calculating credit risk, projecting business performance, evaluating management's performance and conducting a company stock valuation. While this analysis might help a bank make a lending decision or an investor make a buy, sell or hold decision it is always not the best way to discover how to make the business more profitable. And that is what any business really wants to discover – How do we become more profitable?
Unfortunately, most small businesses do not have seasoned accounting professionals as employees but usually engage the services of a bookkeeper or worse yet the business owner or his wife to keep the books. Even in the best case scenario the most you will get from a bookkeeper, owner or wife is a well kept set of books with zero analysis and at worst a complete mess. The only time an experienced CPA will get a look at the books is once a year at tax time and because of the time pressures of tax season rarely has the time to effectively analyze the businesses performance. Most small businesses end up doing things this way to save on the cost of a CPA during the year but in doing so they end up costing themselves increased profitability.
Inside-Out Approach to Financial Statement Analysis
The savvy small business owner will realize that a good CPA will cover the cost of their services by a thorough financial statement analysis with an inside-out approach. One of the biggest drawbacks to the traditional outside-in approach to financial statement analysis is that the only information the accountant or CPA has is the financial statements. They do not have access to the underlying financial records and employees to be able to dig a little deeper into the companies key processes and get clarification on what is behind the numbers. With this inside-out approach to analyzing the financial statements and the underlying accounting records the CPA will be able to gain a complete understanding of the business processes and other key factors that not only impact the results of operations but will reveal opportunities for improvements in both reporting and business processes.
How does he do it and why can't the bookkeeper or the owner do it? They simply don't have the theoretical education in the principles of accounting that allows the CPA to practice the art of accounting. There are so many moving parts in recording all of the transactions that make up the sum total of a business that if you don't have a fundamental understanding of accounting theory coupled with the experience gained over the years working with small businesses that a good small business CPA has you just don't know what you don't know. A good CPA will be able to identify areas requiring further investigation and analysis almost by second nature.
By Products of Financial Statement Analysis
There are many benefits to the inside-out approach to financial statement analysis that will lead the business down the road to greater profitability through a combination of improved operational efficiencies, effective cost cutting measures and identification and tracking of key metrics. One of the main side benefits of the inside-out approach is removing the deadwood from the balance sheet and proper classification of revenue and expenses on the income statement. Now you might be asking how does cleaning up the balance sheet and income statement lead my business to greater profitability? The answer is simple – in order to make timely and effective decisions about your business you must have financial reports that accurately reflect reality. If you have an accounting system full of errors and misclassifications you will be making decisions that are not based on what actually happens but only on what you think has happened – not good.
The second benefit of the inside-out approach to financial statement analysis is that by involving everyone in the business in the process through a series of questions about their business processes with an emphasis on increasing profits the mindset of the employees begins to change. They will no longer only be focused on their specific tasks but will develop a big picture approach to making the business operate more efficiency and effectively. In essence they become more engaged and invested in the success of the business. This change in mindset will pay dividends now and in the future.
So the next time you think of financial statement analysis don't think – how much is this going to cost? – instead realize that with the inside-out approach to Financial Statement Analysis you will not spend money but save money.
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Random Quote“The entrepreneur builds an enterprise; the technician builds a job.”
by Michael Gerber