In earlier blogs I’ve talked about the structure and formatting of reports to enable managers and owners to review them properly and actually engage with them.
One of the things that I have found most regularly in my career in finance, is that most owners are managers won’t take the time or gain the understanding to review all 3 financial statements at the same time. This means profit and loss, balance sheet, and cash flow. I don’t blame them at all as without proper guidance – and in some cases translation – the inter-relationship of the three statements isn’t clear.
I learnt early on from my mentors just how important it is to review all three together. I clearly remember being schooled on the inter-relationships between items in each of the financial statements early on in my career, and how profitability, liquidity, and sustainability are key elements of the long term viability of a business.
For example looking at revenue in the profit and loss statement without looking at debtors on the balance sheet, and cash receipts on the cash flow statement, means you miss part of picture….. “It’s not a sale until the cash hits the bank” I can hear them say….
Looking at expenses without looking at the change in creditors on the balance sheet, or cash payments on the Cash flow statement is again an incomplete picture. The difference between expenses on the profit and loss statement and cash payments in the cash flow statements might be an increase in creditors on the balance sheet (still to be paid off).
Further to this items on the expense lines of the profit and loss statement may be accruals for which an invoice hasn’t been received yet.
It never ceases to feel great when an owner or CEO sees a report that is grouped into areas that make understanding much easier, and they comment on how they can now run their business with much more clarity. I have covered off in earlier blogs focusing on the profit and loss statement for formatting and structure, but this applies just as much to the balance sheet and cash flow statement.
The balance sheet should always be structured into key sections such as current and non-current assets and the same for liabilities, and equity. The cash flow statement should always be structured into sections relating to operations, financing, and investment. These can be broken down further to aid clarity if needed. Breaking out Cash-flow From Operations into Receipts From Customers, and Payments To Suppliers and Employees, and even breaking that out further into smaller groupings really aids the understandability and usefulness of the report.
Having grown up on systems where changing the reporting structure was akin to climbing a steep slippery difficult Mountain that every step could cause an unexpected avalanche of ramifications, it is a pleasant change to do it with the mere click of a button and drag of a mouse in today’s current cloud systems.
Once this structuring is done then the fun part of adding useful business analysis into your reporting begins. A key element of this is plotting your profit and loss statement, balance sheet, and cash flow statement over time, say 12 or 24 months. By doing this you can track trends in the business and understand the relationship of some lines to other lines in your report. Remember that with ratio’s, the trend, rather than the number at a point in time, is the important thing (other than lending covenants of course).
Once you add in non-financial data to the report, and use dashboards, interesting relationships such as aligning the rostering of a retail business with the busy periods of the day, the average price of each of the most popular 10 products being sold, and setting up a purchasing forecast for future periods that allows you to negotiate better pricing with suppliers, all become visible within your reports.
Once these reports are generated for the first time, it’s always a good idea to go and talk to those people in the business who can confirm the findings and relationships, and explain any anomalies. It could be what you are seeing is actually a lag effect and the action plan or conclusion drawn may differ from what it first looks like.
Either way it’s by setting up these reports and getting that extra information and challenging what you think you know that further Insights are gained.