Well-prepared financial statements contain an incredible amount of timely and revealing information about your business’ financial position. What are its strengths? Where are the vulnerabilities and challenges? Is the business making money?
Savvy executives use the information on financial statements—most notably the balance sheet, income statement, and statement of cash flows—to drive decisions and chart a course for the company’s future. Measuring the organization’s true growth from year to year can help assess your policies and financial strategies. In addition, financial statements take on added importance whenever a clean, audited report is requested by a financial institution or compliance agency. Banks use these statements to assess whether the company can meet its obligations, maintain positive cash flow, collect receivables, pay employees and meet creditor obligations.
Some companies will closely monitor the key ratios and business indicators, with a keen understanding of which figures will be most scrutinized by lenders. Here are three key indicators to look out for, and what they say about your business.
The debt-to-equity ratio is used as a standard for judging a company’s financial standing and its ability to repay its obligations. Banks look at the ratio and use it to assess risk in providing a loan. Lenders prefer low debt-to-equity ratios because their interests are better protected in the event of a business decline. Higher ratios indicate the company is being financed by creditors rather than from its own financial sources, which may be a dangerous longer-term trend.
Gross profit margin
Gross margins reveal how much a company earns on projects and customers, taking into consideration the costs that it incurs for producing its products or services. It’s one of the most commonly used measures because it provides a good indication of how profitable a company is at the most fundamental level—including how efficiently a company uses its resources, materials, and hours. As an executive, you should analyze gross profit on projects, products and services frequently throughout their lifecycle. By comparing gross profit at the completion of a project to the estimated gross profit at inception, as well as interim points along the way, you can detect and resolve problems on the project and determine strategies for better controlling costs.
Average age of account receivables
The only thing worse than not having work is doing the work and not getting paid for it. The age of your accounts receivable, therefore, has become an important measure for executives and other reviewers of financial statements. If your invoices are taking longer to collect, questions will arise regarding the status of your projects and clients. Plan to review your Accounts Receivable aging constantly and use as a tool to detect collection problems.
With a narrow view into your company, you’re unable to fully understand what’s behind the door of your business and what might be lurking around the corner. Likewise, with insufficient reporting on financial and operational details, you are forced to make critical decisions on the basis of only a small portion of the information. Check out this guide on business reporting and what to look out for, and ensure that you’re on beat with the beating heart of your business.