Unlocking Business Insights: Using Key Financial Ratios to Analyze Small Business Performance

In the competitive business world, small business owners need to make informed decisions to ensure the success and growth of their ventures. One crucial tool at their disposal are financial ratios, which provide valuable insights into a company’s performance.

By understanding and leveraging financial ratios, you can assess your business’ financial health, identify areas for improvement, and make strategic decisions to drive their businesses forward. This article will explore the power of key financial ratios and how you can use them effectively.

The Significance of Key Financial Ratios

Financial ratios are quantitative tools that help assess a company’s financial performance, efficiency, profitability, and liquidity. They provide a snapshot of the business’s financial health and offer benchmarks for comparison with industry standards and past performance. You can utilize these key financial ratios to understand your company’s financial position and make data-driven decisions.

Liquidity Ratios: Liquidity ratios help you understand your cash flow by assessing your ability to meet short-term financial obligations. You can calculate ratios such as the current ratio and quick ratio to determine if the company has enough liquid assets to cover immediate expenses. These ratios help identify potential cash flow issues and enable proactive measures to ensure smooth operations.
Profitability Ratios: Profitability ratios measure a company’s ability to generate profits and help in assessing business performance. Ratios such as gross profit margin, net profit margin, and return on assets (ROA) enable you to gauge your profitability and compare it to industry standards. By analyzing these ratios, business owners can identify areas for cost reduction, pricing adjustments, or revenue enhancement to maximize profits. We explore many of these in The Ultimate Small Business Profitability Checklist.
Efficiency Ratios: Efficiency ratios provide insights into how effectively a business utilizes its resources to generate revenue. You can analyze ratios like inventory turnover, accounts receivable turnover, and asset turnover to assess operational efficiency. These ratios help identify bottlenecks in the supply chain, inventory management issues, or inefficiencies in resource allocation, enabling you to streamline operations and improve overall efficiency.
Debt Ratios: Debt ratios evaluate a company’s leverage and ability to meet long-term financial obligations. You can calculate ratios like debt-to-equity and interest coverage ratios to assess their company’s risk exposure and debt management capabilities. These ratios assist in making informed decisions about borrowing, managing debt, and maintaining a healthy balance between equity and debt.

Interpreting and Applying Financial Ratios

While understanding these key financial ratios is essential, interpreting them correctly is equally crucial.

You should compare their ratios to industry benchmarks, historical data, and competitors to gain meaningful insights. Additionally, tracking ratios over time allows you to identify trends and evaluate the impact of strategic decisions.

It is essential to note that financial ratios should be used with other performance indicators and qualitative analysis to make well-rounded assessments. You can learn more about some of these metrics in The Ultimate Small Business Profitability Checklist. You’ll also find key financial ratios formulas in a key financial ratios pdf.

Financial ratios serve as invaluable tools for small business owners to assess their company’s performance, financial health, and areas for improvement. By leveraging liquidity ratios, profitability ratios, efficiency ratios, and debt ratios, you can gain a holistic view of their operations and make informed decisions to drive growth and success.

Understanding and interpreting financial ratios empowers you to optimize resource utilization, manage cash flow, improve profitability, and make strategic decisions for your business.

To learn more about how to calculate these ratios using your financial statements, check out How to Read Financial Statements: A Guide for Business Owners.

If you’d like help better understanding your financial ratios why not book a free consultation with one of the experts at Avisar.

Disclaimer: Avisar Chartered Professional Accountant’s blog deals with a number of complex issues in a concise manner; it is recommended that accounting, legal or other appropriate professional advice should be sought before acting upon any of the information contained therein. Although every reasonable effort has been made to ensure the accuracy of the information contained in this post, no individual or organization involved in either the preparation or distribution of this post accepts any contractual, tortious, or any other form of liability for its contents or for any consequences arising from its use.

What is SR&ED

SR&ED stands for Scientific Research and Experimental Development. And if you want to get tax benefits for doing R&D in Canada, you should know about the SR&ED tax credit program.

Our guest expert, Jude Brown, CEO & Co-Founder of Bloom Technical, explains what the program is, how to qualify, and what you need to do to apply.

The SR&ED tax credit program rewards Canadian businesses for doing innovative and risky work in their fields. The CRA runs the SR&ED tax credit program, and it gives you tax credits, refunds, and deductions for your R&D expenses. But only some businesses can qualify for the program.

How Do I Apply for the SR&ED tax credit program?

You need to meet some criteria to be eligible. Here are the main ones:

You must be a CCPC, a Canadian partnership, a sole proprietorship, or a trust. CCPCs get the most benefits from the program.
You must do scientific research or experimental development to create new or improved products, processes, materials, or knowledge.
You must face technical risk, meaning you don’t know if your work will succeed or fail. You must demonstrate your project iterations.
You must keep proper records of your R&D activities, including what you did, how you did it, and what you learned.

To apply, you need to fill out Form T661 and submit it with your tax return. This form asks you to describe your R&D activities in detail and report your expenses and outcomes.

This can be tricky and time-consuming, so getting help from a professional SR&ED consultant is best. They can help you prepare your application and maximize your benefits.

How Big Could My SR&ED Claim Be?

The size of your tax benefits depends on your business type, income, and tax rate. The CRA has different formulas for each factor. The more you spend on eligible R&D expenses, the more you can claim. But there are limits and rules to follow.

Eligible R&D expenses include:

Salaries or wages of the employees who worked on the R&D project
Contractor fees for the arm’s length parties who performed R&D on your behalf
Materials that were consumed or transformed during the R&D project

Some expenses are not eligible for SR&ED, such as capital, overhead, and marketing costs. You also need to prove that your R&D expenses are reasonable and related to your industry. In BC, businesses can expect to get about 64% back from eligible SR&ED expenses.

To get an accurate estimate of how much you can get from SR&ED, contact us today, and we can put you in touch with a SR&ED professional. You can also find extensive information on the program through the CRA.

Disclaimer: Avisar Chartered Professional Accountant’s blog deals with a number of complex issues in a concise manner; it is recommended that accounting, legal or other appropriate professional advice should be sought before acting upon any of the information contained therein. Although every reasonable effort has been made to ensure the accuracy of the information contained in this post, no individual or organization involved in either the preparation or distribution of this post accepts any contractual, tortious, or any other form of liability for its contents or for any consequences arising from its use.

Navigating Estate Planning for Blended Families: A Guide

Estate planning is an essential aspect of planning for your family’s financial future, and it’s particularly important and delicate for blended families. The dynamics of bringing separate individuals together as a blended family create unique considerations when planning for the next generation. Here’s a guide to how you can ensure your family’s financial future is well protected.

Understanding Estate Planning for Blended Families

Estate planning for blended families requires one to take into account the unique dynamics that past relationships, biological relationships, and current relationships create. Bringing two distinct sets of parents and children together is not easy — nor is planning for all members’ financial futures.

Some common issues that blended families frequently face are issues such as:

How to meet the needs of all family members
How to manage unequal assets and incomes
What a fair distribution of assets looks like
Whether children’s inheritance should wait for the death of a step parent
What inheritances from separated spouses might provide
Other issues, such as those already faced in other areas of life

These are not small matters, and they’re bound to bring forth some disagreements that must be worked through. The goal is to work through those with clear and honest communication, as this is how you can keep disagreements from becoming outright conflicts.

Of course, working with an experienced lawyer, accountant and financial planner can be a great help when working through these matters.

Estate Planning Strategies for Blended Families

There are multiple estate planning strategies that families can use to execute their desires. Estate planning for blended families is no different:

Will: One of the most crucial aspects of anyone’s estate planning is creating a well-drafted will. A will serves as a legal document outlining how your assets will be distributed upon your death, ensuring your wishes are carried out and potential disputes among family members are minimized.
Trust: Trusts offer a controlled and flexible way to distribute assets to beneficiaries. This tool allows you to specify when and how your beneficiaries receive their inheritance, providing an added layer of control over asset distribution. It also might have implications in how your savings are spent (or not spent) during senior years. Trusts can be especially useful for blended families that might want to navigate having children in different life stages.
Beneficiaries: Beneficiaries are the ones who receive benefits from insurance (e.g. life insurance) and retirement accounts, and the funds can usually be distributed without going through probate when a person is a named beneficiary. Make sure to update any named beneficiaries of accounts after establishing a new blended family. This typically requires filing a simple form.
Documents: It’s important to plan for incapacitation due to health. Make sure you know who will make decisions, and how they’ll best follow your wishes. Taking care of this requires a living will (for financial matters) and a medical power of lawyer (for healthcare/end-of-life decisions). These may have to be redone after establishing a blended family, if your choice of who takes on each role changes.

All of these should be prepared in concert with an lawyer so that forms are legal, properly established, and thorough.

Special Considerations for Blended Families

Every blended family is unique and has its own nuances to navigate. There are certain special considerations to most blended families, though. When estate planning for blended families, all parties should be aware of the difficulties that are inherent in:

Navigating relationships between biological children and stepchildren
Ensuring the surviving spouse is financially taken care of
Managing existing conflicts between various family members
Handling tax implications that can be extensive and substantial

Again, the key to doing this successfully is open communication and working with knowledgeable professionals. Those who are familiar with the nuances of estate planning for blended families are a great resource and guide for this process.

Get Help with Estate Planning for Blended Families

No matter what your family structure is, don’t neglect to properly go through the estate planning process. If you’re estate planning for a blended family, don’t let the additional challenges stop you from tackling this.

If you have a blended family in the British Columbia area, seek professional help for the best potential process and outcome. We at Avisar Chartered Professional Accountants are here to help. We’ve worked with many blended families, are a leading firm that offers estate planning in BC, and are ready to help you.

Disclaimer: Avisar Chartered Professional Accountant’s blog deals with a number of complex issues in a concise manner; it is recommended that accounting, legal or other appropriate professional advice should be sought before acting upon any of the information contained therein. Although every reasonable effort has been made to ensure the accuracy of the information contained in this post, no individual or organization involved in either the preparation or distribution of this post accepts any contractual, tortious, or any other form of liability for its contents or for any consequences arising from its use.

Federal Budget 2023: Other Measures

Small Business Credit Card Fees

Budget 2023 announced that commitments had been obtained from Visa and Mastercard to lower fees for small businesses. More than 90% of credit card-accepting businesses are expected to see their fees reduced by up to 27%.

Automatic Tax Filing for Low-income Canadians

Budget 2023 announced that the number of Canadians eligible for CRA’s automatic File My Return service will be increased to 2 million by 2025, almost tripling the number of currently eligible Canadians. In 2022, 53,000 returns were filed using this service. In addition, a new pilot project will be implemented to assist vulnerable Canadians in applying for benefits even if they do not file tax returns.

Student Benefits

Budget 2023 proposes increasing Canada student grants by 40%, raising the interest-free Canada student loan limit from $210 to $300 per study week, and waiving the requirement for mature students (aged 22 or older) to undergo credit screening in order to qualify.

Dental Care for Canadians

The Canadian dental care plan would provide coverage for all uninsured Canadians with an annual family income of less than $90,000 (the Canada dental benefit only provided benefits for children under 12) by the end of 2023. The plan will be administered by Health Canada with support from a third-party benefits administrator. Benefits are reduced for families with income between $70,000 and $90,000.

Protecting Federally Regulated Gig Workers

Budget 2023 proposes to amend the Canada Labour Code to strengthen prohibitions against employee misclassification for federally regulated gig workers such that they will receive protections and benefits including EI and CPP.

Ensuring the Integrity of Emergency COVID-19 Benefits

Budget 2023 proposes to provide $53.8 million in 2022-23 to Employment and Social Development Canada to support integrity activities relating to overpayments of COVID-19 emergency income supports.

Disclaimer: Avisar Chartered Professional Accountant’s blog deals with a number of complex issues in a concise manner; it is recommended that accounting, legal or other appropriate professional advice should be sought before acting upon any of the information contained therein. Although every reasonable effort has been made to ensure the accuracy of the information contained in this post, no individual or organization involved in either the preparation or distribution of this post accepts any contractual, tortious, or any other form of liability for its contents or for any consequences arising from its use.

Surviving a CRA Audit: What You Should Know

It’s the letter you never want to receive from the Canadian Revenue Agency (CRA). You are subject to a CRA Audit.

The CRA sends thousands of letters every year to notify people that they’re being subjected to an audit. Of all the returns they receive, it’s usually business taxes that they take a fine-tooth comb to. This is unfortunate because business owners and entrepreneurs are often swamped with numbers, and the last thing they have time for is to parse through each one.

If you want the best chance of successfully getting through a CRA audit, we’ll look at how they decide who to investigate, what you can do to prepare, what’s going to happen, and what your accountant should be doing in the meantime.

Risks for a CRA Audit

The biggest risk for being selected for a CRA audit is the size of your business. The majority of the CRA audit program spending is devoted to small and medium-sized businesses. When they run through all of the numbers, here’s what they’re looking for:

Discrepancies: Officials are looking for gaps and glaring margins between the reports. For instance, if your reported income is different than the average reported income in prior years, this could be a red flag for the CRA. Or if your income is far higher than the norm in your industry, this may trigger the next step.
Deductions: Sometimes just claiming home office deductions, which can include utilities, insurance, and property taxes, can be enough to have the CRA send you a letter. Because many people will claim these expenses when they aren’t explicitly used for the business, many of the write-offs don’t qualify. You may also face an audit if you’re making a lot of charitable donations or medical expenses.
Cash: Dealing with a lot of cash in a business opens the path to fraud because it’s notoriously difficult to track. This is doubly true if you’re reporting loss after loss in a cash-heavy business.
Family: There are plenty of business owners out there who will take advantage of their familial connections to make it easier to pay their taxes. So while plenty of people will employ family members without breaking the rules, you may be flagged simply for having a child or spouse on the books.

How the CRA Audit Process Works

The first step is a CRA auditor contacting you (usually by mail or by phone). They’ll give you specifics of the auditing process and then conduct an on-site audit at the place of business. The auditor is generally looking at the following paperwork:

Tax returns, perhaps and organizational chart or property details, depending on the nature of the audit.
Ledgers, invoices, receipts, contracts, bank statements.
Records of other individuals or entities not being audited (e.g., partnerships, corporations, spouses, common-law partners, etc.)

The records looked at will include those for your place of business but also your personal records as well. They’ll also look at any adjustments made by your bookkeeper or accountant to ensure that they were all completed according to tax law.

By the end of a CRA audit, the auditor will either declare your filing to be a correct assessment, which means that your case is complete and your audit will be closed. Or they may conclude that you either owe additional taxes or that you’re entitled to a refund.

What You Can Do to Prepare For A CRA Audit

The best way to prepare is by organizing all your records and ensuring that there’s concrete evidence to justify your numbers and answer any questions. This can include anything from invoicing history to physical receipts. The CRA requirement is to keep your records for at least seven years before shredding them, though CRA will generally audit within three years of your return being filed.

You can also consider gathering proof for regional shifts in supply and demand for your industry. For instance, if you’ve taken several losses over the course of your business, you may be able to point to general trends that have pushed down revenue among all of your competitors. However, these records are not to be shown to the auditor unless specifically asked for. Simply having them at the ready can help give you a sense of confidence as you move into the proceedings.

In addition, when you’re getting ready to speak to the auditor, make sure that you’ve given some thought about what you want to address with them. Generally, less is more and answer what is asked of you. You should be friendly but also thorough when asking about anything from due dates to expectations. It’s common for people to get flustered when they’re talking to an official from the CRA — even when they haven’t done anything to be nervous about. When the auditor is working with you, they should get the sense that you have nothing to hide.

The Role of Your Accountant During A CRA Audit

A CRA audit can be difficult for many reasons, particularly if you’re a busy business owner who doesn’t have a lot of bandwidth to organize, catalog, and verify every last record. When you have a good accountant on your side, they can help you manage the process from beginning to end. Accountants stand between you and the auditor, making it easier to handle the questions and produce the paperwork they need to close the case.

Disclaimer: Avisar Chartered Professional Accountant’s blog deals with a number of complex issues in a concise manner; it is recommended that accounting, legal or other appropriate professional advice should be sought before acting upon any of the information contained therein. Although every reasonable effort has been made to ensure the accuracy of the information contained in this post, no individual or organization involved in either the preparation or distribution of this post accepts any contractual, tortious, or any other form of liability for its contents or for any consequences arising from its use.

Disappearing Profit: Why Financial Statements Change After Accounting Adjustments

Why do my financial statements show a profit, but then show a loss after my accountant makes adjustments? If you’ve ever asked yourself that question you’re not alone.

Accurate financial statements must reflect many business expenses, and it’s not unusual for these adjustments to change profits after an accountant includes them all. If you’ve received statements back from an accountant and they show less profit than you expected (or loss), here are some possible reasons why.

Sales-Related Expenditures

Financial statements may not immediately reflect all of the expenses needed to produce a product/service.

For example, suppliers sometimes don’t send invoices until after those supplies have been used. Similarly, contracted service providers might bill 30 or even 90 days afterward. If there are still expenditures that will be due, a financial statement should reflect these.

An accountant will be familiar with what sorts of expenses your business incurs when producing its products/services. The accountant will make sure to include any that you might not yet have recorded. Any expenses that your accountant includes will have to be deducted from gross revenues.

Asset Depreciation and Amortization

Depreciation and amortization both account for the falling value of assets. Depreciation applies to physical assets (e.g., buildings, equipment, vehicles, etc.). Amortization applies to intangible assets (e.g., patents, franchise agreements, copyrights, etc.).

As these assets decline in value over time, their costs should be deducted throughout their useful life span. Even if your business doesn’t actually pay to renew or replace an asset in a given year, it theoretically must prepare for the future expense.

An accountant will know how assets can be depreciated or amortized according to tax regulations, and they’ll take care of the calculations for you. Although depreciation directly lowers your business’s profits, it’s something you should do. Your business will likely have to pay the cost eventually to replace the asset, and depreciating assets can provide significant tax benefits as it’s usually a write-off.

Standard Accounting Adjustments

A variety of standard accounting adjustments may have to be made to bring your business’s financial statements in line with accepted practice. Your business’s financial documents also won’t be complete and fully accurate until these adjustments are made.

An accountant will know what adjustments have to be made, and how to make them. Adjustments related to works in progress and inventory are fairly common, and businesses may have specialized expenses, too. Any of these can lower the bottom line when comparing the accurate documents to the unadjusted ones.

Learn how to better read and understand your financial statements with our Guide to Reading and Understanding Financial Statements for Business Owners.

Get Complete and Accurate Financial Documents

While you should always do your best compiling financial documents, realize that they likely won’t fully reflect your business’s finances until an accountant reviews them. You could very well see some adjustments that lower your business’s profits. If you’d like a review of your financial statements book a free consultation with us and let’s talk.

Disclaimer: Avisar Chartered Professional Accountant’s blog deals with a number of complex issues in a concise manner; it is recommended that accounting, legal or other appropriate professional advice should be sought before acting upon any of the information contained therein. Although every reasonable effort has been made to ensure the accuracy of the information contained in this post, no individual or organization involved in either the preparation or distribution of this post accepts any contractual, tortious, or any other form of liability for its contents or for any consequences arising from its use.

How do financial statements help in decision-making?

Most small business owners get started to serve customers and to do something they find fulfilling. Not many find that fulfillment in reading financial statements. Yet these statements not only tell them how they’re doing but also suggest actions to promote future success. They are a critical leadership tool to aide in decision making.

When trying to answer the question, how do financial statements help in decision-making, there are three financial statements that every small business owner should understand. They’re the income statement, the cash flow statement and the balance sheet. Here are some keys to using each for business decision-making.

Income Statement

It’s also known as the profit and loss statement, or simply the P&L. It shows all the revenue and expense for a specific time period, be it a month, a quarter or a year.

It reads from top to bottom. Revenue is the top line, net profit is the bottom line, and different types of expenses and intermediate totals are in between, as follows:

Revenue – Cost of Goods Sold (COGS) = Gross Profit.
Gross Profit – Selling, General and Administrative Expenses (SG&A) = Operating Income.
Operating Income – Interest = Pre-Tax Income.
Pre-Tax Income – Taxes = After-Tax Income or Net Profit, aka the bottom line.

While everyone talks about the bottom line, the most fruitful places to make changes are near the top of the sheet.

Increasing revenue improves numbers all down the line.
Decreasing COGS means finding lower prices for inventory and reducing manufacturing costs.
SG&A can be minimized by actions such as reducing utility and building expenses and targeting marketing campaigns effectively.

The last two expenses, interest and taxes, are areas where a business owner should consider consulting an expert for financial advice.

There are ratios that help a business owner gauge financial health.

Gross Profit Margin = Gross Profit / Total Revenue
Operating Profit Margin = Operating Income / Total Revenue
Net Profit Margin = Net Income / Total Revenue

Ratios vary by industry, so it’s hard to make broad statements about desirable numbers. A professional accountant can help benchmark these against industry norms.

Cash Flow Statement

In accrual accounting, income and expenses on the income statement don’t correspond to cash flowing in and out. For example, when a sale is made, the customer owes money and the income statement recognizes revenue. However, a business can’t spend that money until the customer actually pays.

The Cash Flow Statement shows how much money was generated from (or used in) operations and how that cash was used for investments and where it came from in the form of financing. Even with a healthy income statement, a lack of cash means trouble in the future.

There are two ways to calculate cash flow: direct and indirect.

A direct Cash Flow Statement shows changes in cash from three categories:

Operations: cash received for sales minus cash paid out for inventory, wages and other current expenses.
Investing Activities: cash spent for major capital expenditures minus cash received for retiring them.
Financing Activities: loaned money received minus interest on loans.

The direct method is straightforward but requires keeping track of every dollar received or spent.

The indirect method starts with net income from the income statement. It then subtracts any factor that added to net income but didn’t produce cash (e.g., an increase in accounts receivable). It adds anything that’s subtracted from net income but didn’t reduce cash (e.g. a decrease in accounts receivables).

If cash flow is low or varies greatly from period to period, the business should take action to improve it.

Balance Sheet

A balance sheet lists the company’s assets and liabilities.

Assets and liabilities are classified as current and non-current. Current includes cash, receivables, inventory, and debts due within a year. Non-current includes building, major equipment, and long-term loans.

A healthy company has more assets than liabilities.

Assets minus liabilities equals the third category on the balance sheet, retained earnings. This is the amount of money that has been earned and reinvested. Net profits for the income statement are added to retained earnings.

The current ratio is current assets divided by current liabilities. There’s also a quick ratio, which is like the current ratio but excludes inventory from the assets. If this is greater than one, the company can meet its short-term obligations.

The balance sheet also shows whether a company has enough overall assets to cover long-term debt.

Interpreting Financial Statements

A savvy business owner can learn much from the 3 financial statements, and a knowledgeable partner such as Avisar Chartered Professional Accountants can really unlock the statements and show a business how to improve its financial position. Avisar specializes in taxes, statements, and consulting for small businesses, entrepreneurs and non-profits.

Read our Guide to Understanding Financial Statements for Business Owners for more on how to make the most of your financial statements.

Disclaimer: Avisar Chartered Professional Accountant’s blog deals with a number of complex issues in a concise manner; it is recommended that accounting, legal or other appropriate professional advice should be sought before acting upon any of the information contained therein. Although every reasonable effort has been made to ensure the accuracy of the information contained in this post, no individual or organization involved in either the preparation or distribution of this post accepts any contractual, tortious, or any other form of liability for its contents or for any consequences arising from its use.

How To Review Financial Statements For Accuracy: 5 Timely Tips

As a business owner, you make a lot of decisions based on your financial statements. You track revenue and plan expenses, often to decide how much take-home pay makes sense for you or whether you can afford more inventory or equipment upgrades.

Your financial statements must be accurate to rely on them. We’re going to walk you through how to review financial statements for accuracy.

Keep Up with Your Financial Statements

One of the best ways to ensure your financial statements are accurate is to keep up with them regularly. While creating an annual balance sheet or income statement is a good start, developing monthly updates to your financial statements is much better.

Creating and reviewing financial statements will help you pinpoint concern areas before they cause problems. Being familiar with your balance sheet, for example, will help you determine if something looks a little off. Without that familiarity, you might not realize when something has been misapplied or forgotten altogether. In some cases this can lead to trouble with the CRA when filing.

Review Your Balance Sheet for Red Flags

Your balance sheet provides a snapshot of your business at a specific point in time. Being familiar with your balance sheet will help you spot red flags. Some of the most common concern areas include the following:

Misapplied Payments. If you received a payment from a customer but applied it to the wrong account (or something similar), your balance sheet on an individual customer account is going to look a little off. Look at individual customer accounts for negative balances to help correct this type of error.
Increasing Debt-to-Credit Ratios. A debt-to-credit ratio shows how much debt you have compared to the amount of assets you have. While a rising debt-to-credit ratio might not always signify a mistake, it can give you an indication of the health of your overall company. Huge fluctuations in this ratio can indicate something was not recorded correctly.
The Balance Sheet Doesn’t Balance. Perhaps the biggest red flag is that the balance sheet simply doesn’t balance. In fact, that is the purpose of the balance sheet—to ensure that assets equal liabilities plus net worth.

Review Your Income Statement With Your Cash Flow Statement

While your income statement and cash flow statement report different information, they can and should be reviewed together. Having a high-profit number on your income statement with a low cash flow statement doesn’t really make sense. When these numbers are not in sync, that could indicate a problem with the earnings that are being reported.

How to review financial statements for accuracy — *Income statements and cash flow statements should be reviewed together.*

Unpredictable Reports

Your reports really should be somewhat similar from month to month. When there are huge, unexplainable swings from month to month, there are likely errors that you need to address. Finding them can be difficult, but having month-sized portions to review rather than entire years can be very helpful to start this process.

Get an Accountant and Work With Them Regularly

Having a third party review your books and records can be extremely valuable. An accountant will be able to take a hard look at patterns and reported numbers to determine where there might be concerns. In addition, if you have your own in-house bookkeeping, having an outside accountant review everything provides a valuable second set of eyes to help spot mistakes.

Need help ensuring your financial statement are accurate? Speak with an Avisar advisor or consider one of our packages with coaching.

Ready to learn more about how to review financial statements for accuracy? Read our free guide How to Read Financial Statements: A Guide for Business Owners.

Disclaimer: Avisar Chartered Professional Accountant’s blog deals with a number of complex issues in a concise manner; it is recommended that accounting, legal or other appropriate professional advice should be sought before acting upon any of the information contained therein. Although every reasonable effort has been made to ensure the accuracy of the information contained in this post, no individual or organization involved in either the preparation or distribution of this post accepts any contractual, tortious, or any other form of liability for its contents or for any consequences arising from its use.

Top 3 Things to Look at in Financial Statements for Judging a Business’ Health

Judging how well (or poorly) a business is doing requires a robust understanding of the business’s financials. In a previous post we looked at the three different types of financial statements. In this post we’re going to show you what to look for in your financial statements to know if your business is successful or at risk.

Learn more about how to read and understand financial statements in How to Read Financial Statements: A Guide for Business Owners.

1. Balance Sheet

A balance sheet is essentially a snapshot of a business’s financial situation at a specific point in time. It shows assets, liabilities, and owner equity as they currently stand.

From these figures, you can determine whether a business owns or owes more. Although a single balance sheet provides an accounting at only one moment in time, the financial direction of a business becomes evident if you compare balance sheets across months, quarters, or years.

To see how solvent a business currently is, check its most recent balance sheets’ listed assets and liabilities. The business has positive equity if the assets are greater than the liabilities and has a negative balance if the liabilities are greater. (Owner equity should also be checked but is less commonly an issue.)

You can also see whether current assets (e.g., cash) are sufficient to cover current liabilities (usually due within one year). If they aren’t, the business could have cash flow issues in the coming months.

To see how a business is trending, compare its balance sheet to a previous one (e.g., a quarter or year ago). Asset growth shows that a business is either growing or investing in growth. You likewise can see whether liabilities are declining or increasing.

2. Profit & Loss Statement

An income statement (or profit and loss statement (P&L)) summarizes revenues and expenses over a period of time, usually a month, quarter, or year. Revenues are tabulated and expenses deducted, and the resulting balance reveals whether a business made or lost money during the period.

In the reporting, revenues and expenses are typically broken down into categories. Listing separate categories makes it easier to assess where a business has growth opportunities and/or is spending most of its money. Categories could include online sales, brick and mortar sales, types of products/services, facility costs, wages, inventory costs, and anything else that’s also relevant.

First, look at the overall P&L to assess a business’s general performance. For decision-making, however, check the revenues and expenses of specific categories. You can see whether they’re declining, stable or growing, and you can also see correlations between certain ones. For example, a growth in sales might necessitate higher employee compensation to meet the increased volume.

3. Cash Flow Statement

A cash flow statement converts the profit shown on the P&L to the actual cash generated (or used) from operations. It also shows the cash provided for or used from investing and financing activities.

For example, your P&L may include $100,000 in invoices not collected yet, including in accounts receivable. On the Cash Flow Statement, this will be adjusted as a reduction of $100,000 from the profit shown on the P&L to reflect the actual cash earned.

Cross-reference the cash flow statement with the P&L. The trends of the P&L should continue on a cash flow statement, or there should be a good reason for a difference.

Assess a Business’s Financials

With these three reports, you can accurately assess a business’s financial situation. Compile the reports to check how your own business is doing, or request them as you evaluate one that you’re considering investing in.

It’s also important to be aware that these reports are only useful if all accounts are reconciled and they have been properly prepared considering accruals like revenue and A/P, and non-cash adjustments like amortization and tax expenses.

If you want help examining your financial statements, book a free consultation and we’d be happy to show you what your financial statements are telling you about your business.

Disclaimer: Avisar Chartered Professional Accountant’s blog deals with a number of complex issues in a concise manner; it is recommended that accounting, legal or other appropriate professional advice should be sought before acting upon any of the information contained therein. Although every reasonable effort has been made to ensure the accuracy of the information contained in this post, no individual or organization involved in either the preparation or distribution of this post accepts any contractual, tortious, or any other form of liability for its contents or for any consequences arising from its use.

What are the Three Types of Financial Statements?

The three core financial statements are the balance sheet, the income statement, and the cash flow statement. Each offers unique details about a business’ activities and together provide a comprehensive view of a company’s financial health and operating activities. We’re going to explain each and show you how these three types of financial statements all fit together.

The Balance Sheet

The first of the three types of financial statements is the balance sheet. The balance sheet provides a snapshot of a company’s financial position at a given point in time. It shows the company’s assets (what the company owns), liabilities (what it has borrowed), and shareholders’ equity (investment and retained earnings).

These numbers should balance each other out: Assets = Liabilities + Equity.

A balance sheet can be prepared daily, weekly, monthly, quarterly, or annually. Many small businesses prepare their balance sheets monthly, perhaps quarterly for smaller businesses.

Analysts can use a balance sheet to identify the health of a company using metrics such as the Current Ratio and Debt/Equity Ratio.

Ultimate guide to reading financial statements

The Income Statement

The income statement is sometimes called the Profit and Loss statement (or P&L). The income statement shows the revenue a company earns and the expenses involved in its operating activities.

The difference between revenue and expenses represents the company’s net profit for a given period of time.

It does this by showing the sales revenue at the top and then deducting direct and indirect expenses.

Direct expenses are your cost of goods sold (COGS). This provides us with gross profit. Indirect expenses include operating expenses (salaries, administrative expenses, research and development, etc.) and secondary activity expenses such as interest paid on loans taxes.

The result is a company’s net income.

Net income at the end of a period becomes part of the shareholders’ equity feeding the balance sheet. Net income is also carried over to the cash flow statement

When analyzing the income statement, you should be looking at the company’s profitability using key ratios like gross margin, operating margin, and net margin as well as tax ratio efficiency and interest coverage.

The Cash Flow Statement

A cash flow statement shows how much cash enters and leaves your business over a set period of time. It begins with the net income from the income statement and subtracts any non-cash expenses.

The cash flow statement shows cash coming and going out of the business in three categories:

Operating: Including revenue, expenses, gains, losses, and other costs.
Investing: Debt and equity purchases and sales; purchases of property, plant, and equipment; and collection of principal on debt, etc.
Financing: Including paying or securing long-term loans, sale of company shares, and payment of dividends.

The cash flow statement shows the change in cash per period, as well as the beginning balance and ending balance of cash.

Now that you have an overview of the three types of financial statements, let’s look at how they fit together to give you a really clear picture of the state of your business. This diagram from the Corporate Finance Institute does a good job of illustrating the similarities and differences between the three types of financial statements, and showing you where they intersect:

	Income Statement	Balance Sheet	Cash Flow
Time	Period of time	A point of time	Period of time
Purpose	Profitability	Financial Position	Cash Movements
Measures	Revenue, expenses, profitability	Assets, liabilities, shareholders’ equity	Increases and decreases in cash
Starting Point	Revenue	Cash balance	Net income
Ending point	Net income	Retained earnings	Cash balance

Source: The Corporate Finance Institute

Learn more about how to read and understand the three types of financial statements in How to Read Financial Statements: A Guide for Business Owners.

Disclaimer: Avisar Chartered Professional Accountant’s blog deals with a number of complex issues in a concise manner; it is recommended that accounting, legal or other appropriate professional advice should be sought before acting upon any of the information contained therein. Although every reasonable effort has been made to ensure the accuracy of the information contained in this post, no individual or organization involved in either the preparation or distribution of this post accepts any contractual, tortious, or any other form of liability for its contents or for any consequences arising from its use.

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