Interpreting 6 Key Ratios

In order to make the best use of the three financial statements, business owners need to know how to interpret and compare particular data on them. There are five key ratios:

Current Ratio-(Current Asset/ Current Liabilities) A liquidity ratio that measures the quality and adequacy of current assets to meet current liabilities. In other words, can a company quickly convert its assets to cash in order to meet the immediate and short-term obligations.  

Sales to Receivable Ratio-(Sales/Receivables) A liquidity ratio that measures the number of times trade receivables turn over during the year. The higher the turnover of receivables, the shorter the time between sale and cash collection.

Cost of Sales to Inventory Ratio-(Cost of Sales/Inventory) A liquidity ratio that measures the number of times inventory turns over during the year. The higher the turnover of inventory, the shorter the time cash is tied up in inventory the sooner inventory is converted to cash therefore, increasing liquidity.

Debt to Equity-(Debt/Equity) A leverage ratio that measures how well a company is managing its debt and whether the company is reinvesting in itself or taking on more debt. It expresses the relationship between capital contributed by creditors and that contributed by shareholder.
Profit Margin Ratio-(Profit/Sales) Measures a company’s profitability and how much “cushion” it has.
Return on Assets-(Income/Assets) An operating ratio that measures the effective use of assets in generating earnings.

Interpreting key financial ratios correctly allows business owners to act quickly. Immediate corrective action increases efficiency and profitability -- two improvements all business owners want!  

Business Owners & Reading Financial Statements

In many companies, it is the CPA who performs the analysis of the financial statements. After all, as an accountant, the CPA has expertise in interpreting and drawing conclusions based on financial statements. However, business owners can reap great benefit from learning to read and understand financial statements. The information those statements contain reflects the overall health of the company. When the business owner can identify problematic indicators in the financial statements, he or she can take immediate corrective action.

There are three core financial statements, and each one depicts a different view of the company’s overall financial picture. The balance sheet, the income statement, and the cash flow statement provide three different snapshots of the company’s financial health at a specific point in time such as month end, quarter end, or year end.

The balance sheet provides and overview of the company’s financial position. It measures assets -- what the company owns -- and liabilities -- what the company owes, at a given moment in time.

The income statement reports the profitability of a company for a stated period of time such as a month or year It compares the revenues generated with the expenses incurred to produce those revenues. In other words, it shows the amount of money made through sales, minus what it cost to produce whatever is being sold.

The cash flow statement captures cash fluctuations for a company, at various points in time.  It lists all sources and uses of cash. More importantly, it can be used to gauge how much cash is on hand so that a company can determine if it can pay expenses and purchase assets.

Business owners who are able to read and understand their financial statements develop insights into the overall health of their companies. That additional information allows them to  confidently make decisions on how to move their business forward, often with a competitive edge that others lack.

CPA Meeting Checklist

People dread meeting with their CPA for many reasons, not the least of which is gathering the paperwork necessary for a productive, useful meeting. Here is a quick list of common documents to help you prepare for a meeting with your accountant:

Income Records - Invoices, Bank Statements, and Investment Accounts Your CPA will need all of your receipts, invoices, bank statements and investments. A form 1099-INT, which reflects your savings and interest is also necessary. Performing regular and timely reconciliations of bank statements and having a system for keeping income records easily accessible is helpful.

Schedule K-1 - If your business is classified as a partnership or corporation, you will also need to report any income or loss on a Schedule K-1. This form details individual shares of income within a partnership or corporation.

Expenses - Miscellaneous office expenses could range from supplies to travel, depending on your situation.

Mileage Miles - driven for business purposes can be claimed as a deduction. Save receipts for tolls incurred while driving for business, too!

Payroll - Documentation of employees’ salaries and wages, Forms W-2, W-3, and various forms required by the state will also need to be updated. Up to 20 Form W-2s can be created and printed on the Social Security website. Learn more athttp://www.ssa.gov/bso/bsowelcome.htm. The earnings of people who are hired for specific expertise must be reported separately on a form such as a 1099-MISC. If you are providing retirement plans for your employees, you can claim certain deductions.

Mortgage Interest - If your business operates out of your home you can deduct some mortgage interest, insurance, and some maintenance expenses -- but you must have documentation supporting all of those expenses. People who are self-employed may need to use Form 8829 to claim these deductions.

Office Rent - Expenses related to rental taxes and some utilities may be claimed if your office premises are rented.

Interest - Money that is borrowed for business activities can be deductible, if you have valid documentation showing how it was used.

Insurance - Policies for business coverage may be reported as a tax advantage -- if you have the proper documentation.

How To Effectively Plan for the New Year

Establishing business goals early in the year is critical for businesses because goals set the course for the upcoming months. Planning is far more effective when informed by the past. Using some simple guidelines as you map out your company’s year will help you stay on track when unexpected events and nagging details threaten your progress toward your goals.

Think Long Term Considering where you want your company to be in one, three, and five years as you plan for the upcoming year will give you a global setting for your goals. Just as it makes sense to break large tasks into smaller ones, it is also effective to break your long term goals down into short term goals.

Think Short Term Your short term goals, whether monthly, quarterly, or annually, should act as reference points along the way toward realizing your long term goals. Having short term goals will provide your company with a clear path to longer term goals.

Make Your Clients or Customers Part of the Process Your customers are the most important source of information about your financial future. You probably don’t want to invite them to your planning meetings, but you should certainly consider the information they provide. In addition to using your sales numbers in the planning process, you may want to use surveys and questionnaires to learn more about what your customers prefer.

Ask Your Employees Management does not always have the same kind of contact with customers as other employees do. Including employees from every level of your organization in the planning process may reveal facets of the day-to-day operation of your company that you hadn’t considered. Additionally, when employees have a clear idea of the organization’s overall goals, they more clearly understand how their positions contribute to reaching those goals.
Track Your Progress Assessing progress at regular intervals helps in realizing goals. Regular assessment shows clearly whether a company is progressing toward its goals or has gotten off track. Regular assessment also provides motivation for your team as well as allows you to recalibrate as necessary.