Finance and business are closely intertwined, as every business transaction requires proper planning, reporting, and documentation. The finance is so intertwined that the effect of a payment made to a vendor today can be felt in your profits, inventory, taxes, capital, dividends, and even growth. Financial statements – including income statements, balance sheets, and cash flows – do a splendid job of capturing this financial interdependency across the business by reporting them in accordance with globally recognized accounting standards.
Such standardization makes it easy for businesses to communicate with stakeholders (taxman, government, investors, customers, suppliers), compare businesses with peers, identify trends, make decisions, raise capital, and do much more.
While it is difficult to cover the many uses of financial statements in just one article, here are some of the most common uses.
Using the Income Statement to Optimize Operations
The income statement provides a snapshot of the income a business earned from its operations and other sources, as well as the expenses incurred in earning that income.
Manage Inventory:
You can utilize past financial statements to identify demand patterns, seasonality, and other factors that influence revenue. You can forecast demand and order inventory by analyzing sales by product, store, and month. These parameters can change depending on your business.
Optimizing Expenses:
The income statement categorizes your business expenses into various sections, including Sales and Marketing, Office and Administration, Interest Expense, Depreciation, and others. You can identify areas to cut costs, be warned of overspending, determine the cost per unit to make an educated decision on pricing and estimate costs when growing a business.
Improving Profitability:
Every business has one objective: to earn profits. The income statement tells you how much profit you earned from which source and business segment. Suppose you own a bakery that sells customized cakes, cookies, and breads. Learning that customized cakes have a high margin but lower volumes, whereas bread and cookies sell fast with lower margins, you can create a product mix that gives you a better outcome in terms of volumes and margin.
A professional accountant can analyze all the above trends and make suggestions to keep your operations cost-efficient.
Using Financial Statements to Maintain Business Liquidity to Sustain and Thrive
Cash is like the blood of business, which keeps it alive. If you do not monitor your cash, chances are your cash may dry out, leading to defaults on payments to lenders, suppliers, employees, and utility bills.
Reviewing cash flow statements and balance sheets keeps you updated on where cash is coming from and where it is going. Identifying patterns and areas where money is stuck, such as accounts receivable, excessive inventory, or overspending on capital or dividends, can help you work on the respective area.
It will also alert you in advance about an upcoming cash shortage, helping you prepare for immediate funding. You can determine a cash reserve sufficient to sustain by analyzing past data and running several scenarios. If there is an excess cash reserve, you can put it to use by reinvesting in business, undertaking business expansion opportunities, or paying dividends.
An accountant uses various ratios, such as working capital, current ratio, cash conversion, and more, to maintain business liquidity.
Planning Business Transactions for Tax Efficiency
Every business transaction has tax consequences. For instance, sales and purchases attract goods and service tax (GST), sales of investments or assets attract capital gain tax, salaries and profits attract income tax, and dividends attract dividend tax.
Your financial statements help you calculate your tax liabilities with accuracy and make timely tax payments. If you have any past capital or non-capital losses, you can use them to reduce your current and future profits. You can also decide to buy an asset and use accelerated depreciation to reduce taxable income. Such strategies need to be planned. Tax planning does not happen at the end of the financial year, but before you perform the transaction.
A professional tax expert can study your past financial statements to chart out a tax strategy and save you a considerable amount. Tax planning can even alter the profit margins of two competitors.
Monitoring Business Performance
Every business has different performance parameters, such as average revenue per user, gross merchandise volume, yield on the loan portfolio, and more. All these parameters can be mapped using financial statements.
You may have set up a marketing strategy, opened new stores, launched new products, and restructured debt; now you have to measure its performance. You may have estimated a time frame, or a performance parameter in your plan. The financial statements give you actual numbers and deviations from the forecast. This can help you keep successful projects and scrap poor performers or go back to the drawing board and return with an improved version.
In short, financial statements can be used to compound profits and mitigate losses.
Capital Raising
Every business begins with the owner’s savings. At some point, you might have to face lenders or venture capitalists to raise capital. They are not an easy lot to please. They review your financial statements to assess your business’s risk and return potential. Once you raise capital, you must share your financial statements to demonstrate how you are investing their money effectively.
You can even use the balance sheet to optimize your capital structure for debt, equity, preference shares, and debentures. Debt and debentures have interest costs, and you should have enough cash flows to pay the interest. If interest rates are very high, you might want to consider raising equity or reducing spending.
Planning Business Transition or Sale
Your business can outlive you if it is successful. There will come a time when you must retire and exit the business. Financial statements can help you plan your exit strategy by valuing your business and identifying strengths and weaknesses. A skilled business consultant can determine the approach that can give you the best outcome in a tax-efficient manner.
Complete and accurate financial statements can help you plan a business sale, transition to employees, or to your legal heir. As the statements are prepared in accordance with globally accepted standards, they effectively communicate the business’s financial position to investors, shareholders, and management, facilitating a smooth exit.
Tax and business consultants use financial statements in estate planning, mergers, and acquisitions.
Contact Black and Gill LLP in Etobicoke to Help You Prepare Financial Statements and Put Them to Use
Every business decision – operational, financial, strategic – begins with the financial statement. A professional accountant can help you prepare complete and accurate financial statements and get you started on making informed business decisions. To learn more about how Black and Gill LLP can provide you with the best accounting expertise, contact us online or call us at 416-477-7681.