Making Sense of Financial Statements

Making Sense of Financial Statements

Whether you love or hate reading them, financial statements are critical elements of your business. Don’t ignore them just because you don’t like preparing them or cannot understand them. Potential lenders or investors will rely on your statements when making their decisions to advance funds to you. And you will use them to monitor your progress and to evaluate your performance. Forward-looking statements—such as sources and uses of funds, and cash flow forecasts—allow you to plan as much as it is possible the money that will flow into and out of your business. Historical statements will allow you to see how your actual results compared with your anticipated or projected results. A good accountant can be a valuable resource as you run your business. However, like choosing any professional advisor, take care in selecting the accountant who is right for you and your business.

Why You Need Financial Statements
The statements you prepare prior to starting your business will show where you will get the money to operate your business and what you will do with this money. They also illustrate how much revenue you hope your business will generate and how much money it will take to generate this revenue. You will use this information to prepare and follow a budget and manage the cash that flows into and out of your business. Third-party lenders or investors will use this information to determine whether or not to lend you money or invest in your business.
The financial statements produced once your business is operational will measure your performance. They will help you assess how successful you have been in achieving the goals that you have set for yourself. Investors will use the statements to decide whether they are prepared to continue to support you or if they want their money back. If you need money to expand your business, potential investors or lenders will use your statements to decide whether or not to help you. And if you are looking to merge or sell your business, your financial statements will be critical elements of the merger or sale discussions.

Sources and Uses of Funds
This statement shows where the money is coming from to start your business (source) and what these funds are purchasing (uses).

Forecasting Statements
These statements are attempts to predict what the financial results of your business will be for a set period of time. Like all attempts to forecast the future, they are subject to a wide range of unknowns. They will, however, serve as indications of what you hope to achieve. They will also serve as budget guidelines to help you control spending. When you start your business, these guesstimates will in effect be the results that you would like to achieve. They usually reflect your hopes and dreams more than actual fact. Once you have run your business for a complete year you will have some actual results, which will be the basis of your forecasting for the coming year.

Projecting revenue for the first time is the most difficult aspect of financial forecasting. Your projections will be based on such factors as how much you charge for your goods and services and what volume of revenue your total services will yield. Unless your past experience enables you to determine your revenue, your financial projections will not be based on reliable information. In this case, the best approach is to work from what is known to what is not known. Thus, before addressing revenue projections, which are difficult to determine for the first time, it is best to start by calculating monthly overhead amounts, which are easily identified. Having determined the monthly overhead, it is a simple task to project revenue to meet or exceed these overhead figures.
The example on the next page details typical expense items. It is likely that not all of them will apply to you and your business. And it is possible that your business will have expense items that are not included in this list. As was the case with startup expenses, customize this list to meet your own needs. Amounts for individual items can be based on estimates provided by suppliers or, alternatively, can be estimated as a percentage of total expenses. Although some of the expenses such as accounting/legal and dues/subscriptions are paid in annual installments, they should be allocated monthly.


Cash Flow Forecast
As its name suggests, a cash flow forecast is a forecast of cash flowing into and out of your business. The forecast is based on your predictions of when you expect to receive payment from your clients and when you expect to make payments to your suppliers and to yourself.

➤ Financial statements are helpful to you in monitoring your progress of where you want your business to be, and are also helpful to potential investors and lenders when making their decisions about advancing funds to you.
➤ Forward-looking statements indicate where you would like your business to go.
➤ Historical statements show your actual operating results.
➤ A good accountant can be a valuable asset: Use care in selecting the right one.