As a small business owner, your financial statements can include all sorts of nuggets of valuable information. The challenge is that most owner / operators don’t understand them or know how to read them.

Either you spend a lot of time tracking and creating your own financial statements using a bookkeeping software like Quickbooks or Sage or you pay an accounting firm to create them for you. Then what? Most just file the documents away and proceed with the many other demands of running your business. But taking some time to understand what all these numbers mean will help your business to be more successful.

One way to analyze the data is to review key ratios. Here are few basic ones to get your feet wet in the pool of financial statement understanding:

Average days to collect ratio – what do my financial statements say about my ability to collect sales?

This ratio tracks how quickly are your customers paying your invoices. How does this compare to your payment terms? The longer it takes to collect your sales the more it costs you and the less likely you are going be able to collect on the account. You teach your customers how to treat you. Payment due reminders can be polite and kind. If your customers know you are going to follow up, they are more likely to avoid getting the embarrassing email / phone call and will pay on time. When you receive an on time payment from your customer, thank them; positive reinforcement works for parenting toddlers and for corporate collections.

 

Acid test / Quick ratio – what do my financial statements say about my liquidity?

If you needed to liquidate quickly how well could you do so? If your company needed to pay all it’s accounts payable immediately how easily could you do so? You would need liquid assets equal to or greater than the a/p balance. Liquid assets are cash and receivables.

A ratio higher than 1 is desirable. 2 is most comfortable. But higher than 2 might suggest that your company has idle cash sitting around that could be doing more to work for the company. Consider investment in operational assets, increase staffing levels for higher production numbers, research and development, etc.

 

 

Gross profit margin – what do my financial statements say about how much I am spending to generate a sale?

Gross profit margin compares your sales and the direct costs you incurred to render those sales (direct wages, cost of materials)

A very lose rule of thumb is 1/3 , 1/3, 1/3. Which is – 1/3 of sales is direct costs – which means your gross margin is 33%. The second 1/3 goes to overhead, and the third 1/3 goes to profit which is taken by the owners or reinvested back in the company. This rule of thumb varies through industry and through company size.

Typically gross margin falling year over year is not good, you are spending more on direct costs with out sales also increasing. Alternatively, sales have decreased and you have not decreased direct costs in the same manner. A gross margin that is higher than your industry’s average, that suggests you are stronger than competitors. A low gross margin might suggest you need to tighten controls and do the same production with less resources. Another solution might be to increase your sales prices.

 

 

Try calculating these ratios for your company. If you are struggling to figure out which numbers fit where, send me a note. Chat with other small business owners in your network and begin the conversation of better understanding your financial statements

 

Shanalisa Keller, is a chartered professional accountant (CPA, CGA) with a fondness for Canadian small businesses. She has a passion for increasing the financial literacy of Canadians to support them in being successful in life. She currently runs 3 of her own small businesses; as such; speaks from experience.

 

Like this article? Canadian Finance Gal hosts a 4 hour course on understanding your financial statements if you want to learn more. Shanalisa also does one on one coaching with small business owners to customize the learning so you can better understand where you are at so you can set goals and know where you (and your business) are going.

May you be empowered;

 

Shanalisa Keller is a CPA, CGA and Coactive Trained Coach who founded and leads the team at Canadian Finance Gal. She has a desire to make personal and business finances less daunting and confusing. ⁣⁣She loves accounting and tax and wears the respective geek label with pride. When Shanalisa is not counting beans you can find her mixing a fun new cocktail or building a tasty charcuterie board.⁣⁣ You can read her other blogs on various small business topics here,  book a chat or coffee or wine with her here, or you can find her on LinkedIn (her favourite social platform).