Accounting Solutions Ltd. takes immense pride in serving Chicago businesses. With over twenty years of experience under our collective, our CPAs conduct their day-to-day operations around the values of transparency, customer service, and, of course, accurate accounting. While many of our clients view us as an essential ally for when the taxman comes around, we are also known for our expertise in dissecting financial statements.
To those unfamiliar with the term, financial statements are formal records of the monetary flows of a business. They encompass four broad categories:
1.) Balance Sheets: Statement of the financial position of a business. These encompass all assets, liabilities, and owner equity and are specific to a certain point in time. Balance sheets essentially evaluate the overall net worth of a business.
2.) Cash Flow Statements: Quite simply, these statements cover any money that is being received as a result of the operation of the business as well as any additional external investments.
3.) Income Statements: Income statements look at the bigger picture, and produce numerical values based off calculations revolving around company revenue, expenses, net income etc. These are important numbers as they reflect the overall profitability in terms of gains and losses.
4.) Shareholder’s Equity: This covers the difference between the assets of a business and its liabilities. These financial statements can serve as an analytical tool for understanding shares that are retained by the company in juxtaposition with external shareholders.
When assessing these financial statements, accountants utilize a system called ratio analysis. These number crunching techniques evaluate relationships between different key numbers contained within the statements. Using these ratios, financial analysts and accountants can produce a wealth of relevant data that can help guide the direction of the business. This can include comparisons to other companies, industry standards, and also the past history and transactions of the enterprise being evaluated.
These ratios can be instrumental towards optimizing any business. Their sheer utility is explained through the following scenarios. Please note that, while these are all common scenarios that we have experience with handling, the company names used are fabricated:
Do Sales Equal Profits?
McDunphy enterprises has been excelling in sales. The core of their clientele are repeat customers, and they have noticed steady growth since over the last few quarters. On paper, the numbers look great, who doesn’t like to see the numbers grow?
Well, the owners aren’t necessarily convinced that business is going as steady as they initially thought. Curious as to why the sales aren’t translating into the profits that they have been forecasting, they call upon the talents of a local Accounting Business to help them out.
In order to conduct their investigation, the CPAs use a ratio called net profit margin. This ratio measures the proportion of each ‘sold dollar’ (money that has been acquired through sales) to all of the company expenses. What this reveals is that McDunphy has been seeing increased sales as a result of bigger expenditures on labour and other resources. Ultimately, this financial analysis has revealed that the supposed income of the business has been ousted by expenses. Now, it is up to the owners to work alongside their accounting allies to decide whether their spending decisions have been worthwhile after all.
Watching The Inventory Like It’s A Clock
Al-Corp is a retail company that specializes in a broad variety of product lines and types. Due to the high volume of stock that they keep at their warehouse, their CPA uses a ratio called inventory turnover in order to ensure that they are moving product in a fashion that aligns with their financial goals, as well as the overall momentum observed within the industry overall.
When turnover is slow relative to industry standards, it may be a sign that Al-Corp has too much stock. On the other end of the spectrum, high turnover is generally a good thing, as it shows that the company is selling plenty of stock, a sign that it may be time to up their inventory counts (after a careful analysis, of course). If inventory is not moving at all, it may be a sign that business is slowing to a crawl. If Al-Corp’s primary sales are seasonal, this may be predictable. However, if their products are intended for annual use, then it may be a sign that the business is faltering.
Collecting the Dough
As with many contractor companies, Dingo Enterprises has an established system of credit with the companies that it services. Working together, management and accounting give clients a set period of time to settle invoices. After this time is up, they will start taking action to collect the funds owed, and may even apply interest in more extreme cases.
Due to relatively high operation costs, the average collection period ratio is essential to Dingo Enterprises’ business model. This helps determine when they can expect payments to be received by their accounting team. Dingo Enterprises has to play a balancing act when enforcing collections however; on the one hand, faltering in their accounts receivable will lead to the business leaking money, but, on the other, enforcing a strict collection policy can easily deter customers.
As you can see, there are many applications for this vital financial data. The above examples are only the tip of the iceberg in terms of the number of ways that financial statements and ratios can be utilized by modern businesses. Accounting is not just a fundamental asset when tax season rolls around, it is the lifeblood of many businesses. Got questions? Give Chicago’s trusted CPAs at Accounting Solutions Ltd. a ring.