Many companies prepare financial reports simply because they know they are required to. Their private investors may expect quarterly earnings reports; their banks may ask for periodic updates to assess the company’s liquidity; and government agencies like the Securities and Exchange Commission may require the company to disclose pertinent information to the public. However, financial reports are also fantastic tools to help owners see trends in their businesses. The following questions are ones business owners can answer for themselves by utilizing their financial statements and reports.
Are margins increasing or decreasing?
From the financial statements, a company can determine which relevant margins are increasing or decreasing over time. Executives, for example, will be interested in their company’s profit margin. Profit margin is calculated by taking profits divided by sales, and this ratio reveals how efficiently the business is using its resources. Executives will also be interested in the company’s operating margin, which is calculated by taking operating income divided by sales. This ratio can reveal information about the company’s cash position. Calculating these ratios, and then comparing them over months, quarters, or years, can help executives see trends that they may not otherwise be able to see.
How do operating segments compare?
The types of ratio calculations discussed above can also be performed using information collected from each operating segment individually. These calculations may require some up-front work within the accounting software, but once these reports are up and running, they can be very enlightening. These calculations can reveal which products or services are outperforming others, and can give insight into what small changes need to be made to improve the company’s overall financial position.
Are there unexplained outliers?
Reports are fantastic for determining abnormalities in a business’ operations. Financial reports can reveal when there is a new expense in that period, if receipts are down in another period, or when during the year certain services are popular. Noticing these outliers can help a business improve its efficiency. If, for example, a company notices a surge in one of its operating segments during a certain point each year, the company can choose to adjust its marketing efforts accordingly during those peak months. Or, a company may notice that receipts decrease during a certain time of the year –perhaps around the holidays or at year-end. The company may choose to slightly alter its billing frequency to avoid burdening clients during inconvenient times.
Does the budget realistically represent the true cost of operating?
Budgets are fantastic sources for business owners, but they are often misused. A budget should never stand alone; it should always be compared to actual reports. Budget-to-actual reports can be formatted to show a “budget variance” –that is, they can show the severity at which the budget differs from the actual performance of the company. Executives can use this information to determine when to take action or when a budget needs to be altered.
Should we be concerned about fraud?
Financial reports can reveal much about the company’s performance, and the trends can often uncover instances of fraud. Fraud can be revealed in almost any analysis of the financial statement, but two ways to look for fraud are to utilize a vertical analysis and a horizontal analysis. A vertical analysis compares information on financial reports to industry norms. A horizontal analysis compares current-year data with previous years’ reports to show abnormalities over time. Once unexpected or unusual trends are revealed, the company can investigate further to determine if fraud was at play.