How to Interpret Your Financial Reports

Collecting financial data is well and good — but do you know what to do with it? Your annual reports and balance sheets won’t benefit your business’ financial health if you don’t analyse them.

When used properly, your financial reports allow you to make informed decisions. Interpreting financial reports tells you when you can afford to hire someone, when you need to cut back on travel expenses, if your operating expenses are skyrocketing during the summer, and more.

Let’s talk about which financial reports your business should have and how to read them. Keep in mind, a virtual bookkeeping service can handle a lot of the heavy lifting so you don’t have to.

Essential financial records for every business

With the right financial reporting, you have fast access to everything from your current costs of goods sold to your most recent accounts receivable. You can pull up day-to-day data like transactions and analyse important overall financial ratios, including your debt to equity ratio. Interpreting financial reports in a meaningful way requires the right data.

You need the right documents on your side to be financially literate about your organisation’s debts and assets. Here are some common documents any business should have in their financial reporting process.

Let’s evaluate each form first, then we’ll break down how to read them.

Balance sheet

The balance sheet is one of the most important living documents for any business. It reflects your current liabilities (debts), current assets (including money and property), and your stakeholders’ equity share. The formula typically used for this document is: assets = liabilities (a negative number that reflects money owed) + shareholder equity (a positive number that includes earnings and investments).

What is the goal of a balance sheet? This document reveals the value of your assets, current debt, and cash in the bank at a specific moment in time.

Profit and Loss statement

This document is sometimes called a profit and loss statement. As the name suggests, it lists your net income for a specific period of time. An income statement includes information such as your total revenue, the cost of goods sold, gross profits, operational expenses and interest costs. An income statement is often done as an annual report and compared to previous years.

What is the goal of an income statement? Businesses use this report to calculate their net profits after debt and expenses are considered.

Cash flow statement

Cash flow statements are narrow in scope but important nonetheless. This document specifically measures the actual cash going in and out of your organisation. It includes cash you gain from operations and sales, cash gained or spent for investing, and incoming cash from financing/loans.

What is the goal of a cash flow statement? Interpreting your cash flow statement lets you know how much hard cash is coming in and how much is going out. Obviously, you want a positive number that represents more money coming in than going out.

How to interpret your financial reports

Interpreting financial reports takes time and consideration. Your analysis will be better if you know what to look for. Bookkeeping for professional services can be especially tricky because you may be counting billable hours as opposed to tangible assets, and outstanding debts affect your cash flow.

When are your financial reports promising and when do they spell trouble? Here is how to read these three important documents.

How to read a balance sheet

Your balance sheet gives you a snapshot of your businesss book value at a moment in time. When you subtract the debts from your equity to determine assets, remember that this figure can change — quickly. View your balance sheet as a temporary state of health. It does not reveal trends and it may not give you accurate projections.

You should interpret the resulting calculations in a balance sheet as the state of your company’s financial health at the current moment. It can reveal if you are in the red or black. To identify larger patterns, you will want to combine the knowledge uncovered here with annual profit and loss statements and your year-over-year cash flow.

How to read an income statement

This report does offer you a look into business trends. Financial statement analysis related to an income statement may include an evaluation of gross profit (revenue minus cost of goods sold), a tabulation of expenses, a look at depreciation of equipment, and the total income before taxes.

Things to look for in an income statement include when profits are highest and when they are lowest. Do you make less during winter months? If so, you can begin to brainstorm a way to cut costs then. You may also want to look at when costs are highest. An income statement should also be used to figure out how much money is spent to produce your product or services.

How to read a cash flow statement

A cash flow statement is a part of your income picture. It can reveal patterns about where you are spending most and which streams of income bring in the most actual cash. Keep in mind that it only shows you cash flow for the defined accounting period. For big picture analysis, you want to construct annual cash flow reports.

You want to analyse cash from operating, investments, and bank financing to get the most accurate picture of your cash flow. Cash coming in is called income and cash you spend is called out-goings. Your online bookkeeping should keep cash flow analysis separate from your revenue reports.

How to read an annual report

Many businesses put out an annual report that reflects their overall financial health. This report is often aimed at potential investors. The report combines the cash flow assessment, latest balance sheet, and an income statement.

If you are reading an annual report to potentially invest or acquire the company, pay attention to overall profits versus losses. Ask yourself if the business is able to pay its debts when they are due. Look at how quickly the business and its revenue has grown. Annual reports also contain information about what it costs to maintain the business.

What does a financial report tell you?

A valuable part of interpreting financial reports is being able to make informed projections and decisions. But what can financial reports about your company tell you, and what can’t they tell you?

What an in-house financial report can tell you

Your financial reports can help you better understand a lot of aspects of your business affairs. You can identify trends and areas of overspending. In addition, your finance reports can tell you things like (but not limited to):

The growth rate of your revenue
How quickly you are paying down debt
Your payroll budget
When supply costs are lowest throughout the year
The current ratio (assets/liabilities) of your business
Net annual profits
Total financing expenses (interest and fees)
Non-current liabilities like leases
How quickly an asset is depreciating
When you can afford to give pay raises

What an in-house financial report can’t tell you

There are some things that your own reporting can’t tell you. To better predict your full financial future, you may need to analyse some outside sources and look to industry experts. For example, your business’s financial reports can not offer a comprehensive answer to:

What will our payroll costs be? You may be able to plan your hiring schedule using your existing information. But, you can’t usually predict when employees will leave. Turnover is expensive and yet it’s not something the previous year’s financial analysis can totally predict.
What will our material costs be? If you work in construction and the cost of timber skyrockets, your budget will need to change drastically. You’ll need to turn to industry forecasts to estimate these expenses instead of business reports. The same is true of materials in most industries — outside cost trend information is key.
How quickly can we grow? You can make a great marketing plan and predict sales growth. But sometimes it takes trial and error to determine what best resonates with your clientele. Internal reports are helpful with growth plans, but you also need to analyse competitors and industry trends.

How to tell if your business is financially healthy

The main purpose of interpreting financial reports is to determine the health of your organisation. Are you thriving or flatlining? Look for steady reduction of your debt-to-asset ratio and an increase in cash flow for signs of overall health. You can also count lower costs and increased sales as a sign of good health.

For a more complex analysis of your financial picture, consult with an expert. A virtual bookkeeper will make sure you never miss a quarterly report. Even better, they can provide insights about your accounts payable practices, your current liabilities, and operational costs. You’ll learn about red flags when there is still time to do something about them.

Need some help interpreting financial reports? Learn how Visory can help you generate financial reports for your business and then give you advice.

Guide: How to Interpret Your Financial Reports