Reading and interpreting financial statements isn’t always easy. The weave of numbers and the scare of the arithmetic can be confusing and a sore to the eye—especially if numbers aren’t your thing. When running a business or taking on a vital role in an accounts office where crunching the numbers is inescapable, financial statements are something to deal with constantly. You, therefore, must be in the loop about what’s going on with the numbers. The good news is that you don’t have to be a math whiz to get it. In this article, we’ll explain how to read financial statements like a CFO, even if numbers aren’t your biggest liking.
What are Financial Statements?
Financial statements are formal records summarizing your company or organization’s financial performance and position. These records provide a clear picture of the financial health, mostly indicating the direction of the company—whether right or wrong. They include income and cash flow statements and balance sheets. These documents can either be simple and easy to interpret or complicated and mind-boggling. If you hate numbers, your office days would be long and tedious.
How to Read Financial Statements Like a Pro
The numbers and complex arithmetic can be baffling, especially if you’re not a numbers person. However, there are just a few ways to make all that challenging work as easy as ABC. Here are ways to read your financial statements like a CFO.
The Income Statement
The financial statement tells you whether you made a profit or need to keep up. The reporting can be monthly or on a quarterly or annual basis.
Revenue (Top Line)
This is the total amount your business earns from selling products or services. Try figuring out if your revenue is going up over time. If so, your business is growing, but don’t celebrate yet—this is only the top line.
Cost of Goods Sold (COGS)
This is what it costs you to make or buy what you sell. If you sell hats, COGS includes what you paid for the hats, shipping, and perhaps warehouse storage. Ensure this value isn’t incredibly high, as it will affect your profits.
Gross Profit
Now, subtract COGS from revenue to attain Gross Profit. This tells you how much you made before paying for other expenses, including rent, salaries, marketing, etc. A shrinking gross profit could mean your costs are rising faster than your sales.
Operating Expenses (OPEX)
These are all other costs involved in running your business, including rent or utilities, employee salaries, marketing costs, insurance, and office supplies. If these expenses are rising too fast or there are areas you seem to overspend, trim them lean but not to bare bones.
Operating Income
This is the amount left after subtracting OPEX from the gross profit. Some income statements call it EBIT (Earnings Before Interest and Taxes). A positive operating income means your business is making money. If it’s negative, it could mean something is off with your costs, pricing, or efficiency.
Other Income or Expenses
This is money coming in or going out that isn’t part of your standard business operations. It can include selling equipment or earning interest from a savings account.
Taxes and Interest
High interest could indicate high external debt. Taxes are unavoidable, but proper tax planning can go a long way.
Net Income (Bottom Line)
This is the amount left after everything; it’s your actual profit and what matters. If it’s consistently positive, your business makes money; the opposite is true.
Remember to compare month-to-month or year-to-year because trends matter more than one-time results. Moreover, watch your margins; low profits with high sales might mean bloated costs. If possible, separate fixed and variable expenses to understand what changes with sales volumes. Don’t look at the totals, but understand what’s driving those numbers.
Balance Sheets
A balance sheet offers a financial snapshot of your business at a specific point in time. It follows a simple equation: Assets = Liabilities + Equity. In other words, everything that the company has (Assets) must be paid for either by borrowing money (Liabilities) or through the owner’s own investment (Equity).
Reading a balance sheet like a CFO means looking beyond just the totals. Compare the current year’s numbers to previous ones to spot trends. Then ask yourself, is the inventory relying too much on borrowed money? A good CFO that can be part time or full-time in a company watches the balance between current assets and liabilities, ensuring the business can survive dips in sales or unexpected expenses. Also, be sure to check if long-term liabilities are manageable based on the business’s profits. The goal is to ensure the company stays healthy, balanced, and flexible enough to grow.
The Cash Flow Statements
A cash flow statement shows how cash moves in and out of your business during a specific period, typically a month, quarter, or year. This statement doesn’t always care about account rules, accruals, or what you’re owed. Instead, it only cares about what hit or left your bank account.
Focus on the big picture when reading your business’s cash flow statement. Your goal isn’t to memorize every digit but to understand your business’s overall health and ability to generate cash. Focus on the trends and patterns—is your cash flow improving over time? Are there any significant shifts in your inflows and outflows? If the net cash flow is positive, especially from operating activities, that’s a good sign. It means your business is making money from its daily operations.
If possible, focus on what matters while ignoring the small stuff. Big ticket items like the “Operating Activities” section should be where your attention goes. The net income (profit) should be your starting point. From there, check if it’s positive or negative, and then quickly scan for significant adjustments like depreciation or changes in working capital. Huge fluctuations in inventory and accounts receivable could indicate a cash crunch down the road.
Don’t also forget to check the red flags. A negative operating cash flow, high investing overflows, or financing cash flow all herald a possible financial strain that may require prompt addressing. Also, as a CFO, you’ll want to focus on trends and not just one-off events. Concentrate on the cash flow. Is it growing or shrinking? Compare this information to your budget or forecast to see if you’re on track or need adjustments.
Statement of Shareholders’ Equity
This financial statement tracks movements in the equity section of your balance sheet. Simply put, Equity is the ownership value of the company, and this statement indicates how much shareholders’ Equity has increased or decreased over time. Here’s how to read shareholders’ equity statements like a CFO.
Check Retained Earnings
This is the portion of profits the company has kept that is not paid out as dividends. If your company is profitable and reinvesting in itself, this value will grow, and the opposite is true.
Focus on the Overall Trend In Equity
Be keen on how the total equity has changed. If it’s increasing consistently, the company is growing in value. A sudden drop could indicate financial trouble or large payouts (like dividends or share repurchases).
Consider the Company’s Dividend Strategy
If dividends are high, it might signal a stable, profitable business. Nonetheless, it could still mean the company isn’t reinvesting enough into its growth. On the other hand, if dividends are low or nonexistent, the company might prioritize reinvestment over paying out to shareholders.
Conclusion
While reading financial statements can be pretty challenging—especially if numbers don’t appeal to you—understanding them is still possible. The world of business finance can be pretty intricate, but mastering helpful strategies can help you read your financial statements like a CFO.
