Using your financial statements

So you trust your financial statements and are wondering what to do with them now? Good, let’s check out how to move forward. Having numbers you can trust is a great start to building a sustainable business. Reviewing your clean financials monthly will help you stay on top of your company’s performance and make more educated decisions.

If you’re short on time, compare results to the prior month, prior year, or both, identifying and exploring the key changes between the two periods. Focusing on the high level metrics like, Net Income (the bottom line), Gross Margin (Revenue minus Cost of Goods Sold), and General and Administrative Expenses will help focus your attention on any significant fluctuations.

Often, valuable insights can be pulled from these differences. A drop in sales due to operational challenges, increased sales from a successful marketing campaign, increased expenses in preparation for a growth period, etc., can all be highlighted through this process. Being able to identify and explain these situations will help ensure the strategies and tactics are effective or if any adjustments are needed.

Build a budget

You’ve likely heard “fail to plan, plan to fail.” The annual budget can be thought of as the financial plan for your organization. When putting together the budget you will need to think through your revenue streams, the costs of producing your revenue streams, and the overhead expenses required to operate your business. It will be important to balance the attention to detail this exercise requires without spending too much time away from executing. Once you have completed your budget, you will have your target numbers to focus your day-to-day activity around and another measure to compare actual performance against.

Identify Key Variances

Comparing actual performance to expected performance (budget) is helpful for decision making. This exercise provides the opportunity to assess how initial assumptions play out in the real world. In some cases, comparing a month’s (or quarter’s) performance to the prior period (month or quarter) or the same time period for the previous year could serve the same purpose as a full blown budget. When intentionally focused on growth, taking the time to budget is likely the right option - at a minimum to align the team. Monitoring the difference between budget and actual results highlights areas of your business to focus your attention on.

Profit Drivers

We know that increases in profitability are driven by increased sales or lower costs. In the budget to actuals table above, the increase in the Sales 2 channel and decrease in COGS 1 is worth understanding. These two line items account for the majority of the $950 more profit than expected and knowing whether there was an unplanned scenario that caused this difference or if it was due to a successful marketing campaign and an effort to renegotiate with vendors. A successful marketing campaign and vendor negotiations will lead to longer lasting benefits compared to a one time sale or vendor rebate. Understanding the “why” behind your improved profits will help you keep the profits coming and avoid more unexpected disappointments.

Deficit Drivers

Though in business nothing is guaranteed and unexpected events happen, identifying and exploring these events are important to our growth. Looking at the budget to actuals table above, we can see Sales 1 disappointed and COGS 1 and Marketing were over budget. There is a story behind these differences that helps shape how to react to the lower revenue and/or increased expenses. A discount, refund, or invoice write-off may result from an internal issue which, though unfortunate, (hopefully) was known and expected or, if unknown and unexpected, it could highlight a breakdown in process needing to be addressed. Similarly, if a team member signs up for expenses not discussed as a team it may prompt an expense approval conversation. Seeing a trend in the wrong direction is never fun but finding out what caused the lost income or rising expenses helps keep it from happening more in the future.

Corrective Action

Calling out trends in the wrong direction without identifying steps to address it is asking for the poor performance to continue. It is important to identify the drivers of profitability to look to double down and maybe more important to identify the drivers of deficits to rally the team around stopping the bleeding. The monthly report above shows a negative trend in Sales 1 starting in Month 4. The sooner this trend is identified and understood, the better. It may be the result of under-investing in marketing with a quick fix by reinvesting. Deeper changes in the market could also be driving the change which may require more thought and attention to resolve. Digging into the financial statements can help uncover hidden insights, whether hidden intentionally or not, to course correct negative trends.

Celebrations

With the speed of business, it is important to celebrate the successes along the way. Slowing down to appreciate what is working when there is always room for improvement helps to keep morale high. Take the time to talk about situations like the Sales 2 line in the monthly chart above where the product or service appears to be gaining strong momentum. A growing bottom line, new partnership, or exciting prospect are all reasons to celebrate and sometimes these celebrations do not show in the financial statements. Maybe trusting your financial statements and taking the steps to better use your financials is your celebration and if so, congratulations, I hope you quickly see the reward for your discipline and effort.