For successful companies, timely and accurate financial statements are the cornerstone of sound financial management. While the information is historical it provides information critical to the management of any business. The meaning of the numbers comes alive through meaningful comparisons and analysis. Yet there are many business owners that miss the opportunity to manage their business because of their belief in certain myths. Here are a few truths behind the misconceptions.
Myth #1: Financial statements are just history – I manage my business forward.
Any business owner that thinks like this doesn’t understand the constant loop between financials and the budgeting process. Budgets need to be dynamic, adjusting to changes in goals or results. Planning means understanding how your business will reach these goals.
Historical financial statements must be the bedrock on which your budget/plan is built. While you can prepare your budget independently from the prior year’s financials, it’s important to bridge the information back, define differences and consistencies and plan accordingly.
It’s also important to understand that budgets are worthless without results to compare them to. Comparing actual results to budgets will tell you where you over-performed or under-performed, where you have opportunities or unexpected superior results.
If you don’t take the time to compare budget plans to monthly financials, you are letting opportunity pass you by.
Myth #2: I don’t really understand my financials, but they seem to keep the bank happy.
Believe it or not, this statement is too common. Obviously, the banking relationship is a critical one, maybe one on which the life of the business heavily relies on. But, why hand financial statements to the banks without understanding how the bank is going to use them? You need to be able to look at your financial statements like a banker.
Business owners need to know the answers to questions such as: What are the points that are critical to the bank? What parts of these statements worry the bank (i.e. losses, excessive leveraging, poor current ratio, inappropriate asset investment)?
Myth #3: My financials indicate I made (or lost) money, but I don’t believe it.
Not many business owners say this out loud. It is not responsible to allow disconnect between your perception of your business performance and the reality because there is wonderful knowledge in understanding the difference.
First, your financials are based upon certain assumptions or accounting policies, which may be minor in some businesses and huge in others. These may include depreciation calculations, amortization, bad debt recognition, revenue recognition and tax provision computations, etc. You need to understand these policies and be okay with them. You cannot productively discuss your financials without basic agreement on the appropriateness of these policies, or how these policies are applied.
It’s important to understand that profits don’t always feel like profits. Profitable businesses can and often do have negative cash flow. A vendor screaming for payments or wondering if you can make next weeks payroll doesn’t feel like profits. Similarly, cash flow issues can mask losses. Business owners need to learn to understand their cash flow statement, not just profits, and building appropriate plans.
In any case, it’s important for you to ask questions about your financial statements and how they impact your business. If you don’t understand the answer, keep asking until you do understand.