23. The Art Of Reading Financial Reports
Reading and understanding financial statements doesn't require a finance degree. You can get all the information that you need to make decisions by following these three basic rules.
Reading your financial statements is more of an ART than a science.
Hey, so welcome, I'm just gonna talk about what I call the ART of Reading your Financial Reports.
Financial Reports are an art not science
So ART is an acronym for assumptions, relationships and trends. And it's just to help you think about your financial reports in a different way 'cause sometimes we can get caught up with the hustle and bustle of managing and the fires that we have to put out. Then we have to go and read our financial reports or do a budget or whatever, and we sort of see it separate from what's actually happening in our business. But we've gotta remember that financial reports, they're just really a reflection of what's happening in our business and sometimes it can actually help us uncover what we need to do to sort of put our business back on the right track or to have a better outcome.
So the first thing is A is for assumptions, is making sure you understand what the assumptions are in your financial reports. And I spoke about this in another video, is understanding when is income actually considered income. And so what I mean by that is, come to the end of the month and the salesperson has gone out and someone's put in a purchase order, and so then the salesperson wants that income to be put into that month 'cause it's gonna help his or her commission. Where the accountant is like, no, not until we've actually delivered the service, then we are going to bring that as income.
On the other side of the scale is businesses who are slow at getting out their invoices. So in some industries, people aren't getting their invoices out 'cause they don't have the right systems or just for why the industry, some they're not getting their systems out, getting their invoices out in a timely manner. And so they're reading their financial reports, you need to know what's gone in there and what has gone out.
And conversely for the expenses, you need to know what expenses has gone in there and what hasn't.
So the next one is relationships and we're gonna talk about two different sorts of relationships. The first sort is, when you're looking at your reports don't look at them as a single line and sometimes it's the managers in larger organisations aren't getting all the reports they actually need.
So this is where you need to build a relationship with your financial department or with your accountant or whatever so you can get the reports you need. 'Cause many times the accountants are doing many different reports which could actually help you manage your business better, but they don't know that you need it and you don't know that they're actually producing it. But when you're looking at relationships in your financial reports, you don't wanna be looking at your things just from a budget perspective in that, here's this line and this is where we are compared to budget.
Remember, your financial reports are a reflection, they're a story of your entire business and so there's many relationships. You know when a person sells something, it's related back to the inventory or the stock or the GP. And so what I recommend is your P&L or income statement, you put that, and then you have your balance sheet, and then also you'll have a dashboard with KPI's and they'll have non-financial KPI's as well as KPI's.
So then you're looking for some of the relationships, so you might have, you'd be looking at sales, your accounts receivable, over here you might have your GP percentage, your growth. And so you're sort of looking at what's happening here, what's happening across all those ones. So sales might be growing, so your growth is up, but your GP is dropping, so your salespeople are going out and putting things on sales, so that your sales are actually going up but your GP is dropping.
Or you might have a big sale that's being put in at the end of the month, and so your accounts receivable has gone right up, so your income statement for the month looks really good, but you haven't collected that money or you haven't actually sent the thing out. So it's looking for those sort of things in your financial accounts just to see what's going on.
Thirdly, is you're looking for trends. And the first indicators that I always look at when looking out for trends are the seven drivers of cash flow. One of the reasons I'm looking for trends is because of pattern recognition. Because we're all creatures of habit and business is not a separate entity, it's just made up of people, we're all people and we all have our habits and businesses have their own habits. And so you're looking for trends, so you can see, for early warning signs and that sort of stuff, but you're looking for pattern recognition.
So one of the ways you can look at it is looking at some of the, well like I said before, some of the seven drivers of cash flow. So you're looking at growth, or your GP percentage, or your accounts receivable days, and you're looking at over say a number of months. Because if you're just looking at your P&L each month, I don't, well maybe you do, you don't have the memory to see the way that things are going.
So by having a dashboard, and you're seeing the way that, you can start seeing well things are going down. The other thing is that it'll help you, once you've done it for a couple of years, you'll start seeing the seasons that are in your business. And all businesses go through seasons each year. You know retail has their big season at the end of the year in December and then they have a low season. And all business is the same, so understanding the seasons that you're in.
So hopefully that's helped you to give you some different perspective on reading your financial reports. So remember, understand the assumptions, look for the relationships, and then also understand the trends that are happening in your business and you're gonna be able to make better decisions for better outcomes for your business. So thank you very much and I'll see you in the next video.