Damnant quod non intellegunt. Translation: “They condemn what they do not understand,” which is often quoted as, “People fear what they do not understand.”
During a review of a month end income statement a business owner looked me straight in the face and said, “Well, it shows a loss, but we know that can’t be true. We were busy.” As disturbing as that was to me at the time, I have since heard similar statements from owners and managers on several occasions. In many cases, owners pay little or no attention to the financial well being of their company. They will review their profit and loss statement and stop there.
Not being able to understand financial information well enough to actually put it to use in a business is, unfortunately, a very common problem. My belief is that it’s not that owners and managers cannot learn to read financial statements, but rather that they are afraid to admit it. Unless their background happens to be in accounting or finance, most owners or managers have had little or no exposure to or training in reading and using financial statements. Often times when presented with information that owners and managers do not understand they will nod their head acting like they understand when, in fact, they really don’t.
While I can’t teach you everything in this article about understanding your financials, I can provide you with some tips to start you on your way. Here are some keys to effectively using financial statements.
Use benchmarks.
If you asked me how the Packers did in their last game and I replied “they scored 45 points” what would you conclude? It doesn’t really mean much without knowing the other team’s score does it? Financial statements are very similar. Without some type of benchmark to measure yourself against it is hard to gain a real perspective as to where your company stands. There are two primary sources of benchmarks. The first is to establish benchmarks based on past performance. We can measure ourselves against others through the use of industry standards. Either way we need a base point to truly know if we’re getting the results we desire.
There are two common mistakes. The first mistake that I see is establishing too many benchmarks. I’ve seen companies with 20 key performance measurements. That’s too many. I recommend that you start with 5 benchmarks that are important for your company. The second is using someone else’s benchmarks. Not every benchmark is meaningful for every business. Think about what you need to measure.
Get to know all of your financial statements.
Your “financial book” has three chapters, the balance sheet, income statement, and statement of cash flow. You need to read all three to understand the story. It is all too common for owners and managers to look at the income statement and ignore the other two. The reason is that the income statement is the most easily understood. We all can understand the concept of revenue – expenses = income. But focusing on that statement and ignoring the others can make us blind to other trends happening in our business. The statement of cash flows provides us with valuable information about where our cash is coming from and where it is going to. The balance sheet provides us with an overall picture of the financial health of our company. Each statement will provide us key information that is not available in the other two.
I’ll often hear someone say “the cash flow statement is the most important” or “you have to focus on the balance sheet”. The truth is there is no one statement that is more important than the others. They are intertwined and as important as it is to understand each statement, it is just as important to understand how they relate to each other. Neglecting any one of them is like having a missing leg on a three legged stool.
Ask for help.
Don’t be afraid to ask for help in order to understand your statements. “I don’t understand” is an underused phrase. Don’t expect others to make sure you understand what they are talking about. If you don’t get it say so. As owners and managers we look at it as a sign of weakness when in actuality it is the opposite. If you don’t know what you’re looking at speak up and say so. Ask for help. Find someone who can teach you how to read, understand, and utilize the information provided by financial statements in your business.
Project.
Financial statements are historical. They tell us what has already happened. They can however provide some insight as to what might happen in the future. Putting together projections or proforma statements is a good test of your understanding of the current statements. If you don’t understand what happened in the past you will struggle trying to predict what is going to happen in the future.
While it took some time, I eventually came to realize that the root of the mistrust came from a basic lack of understanding of financial statements. Not taking the time to know and understand your financial statements places your business at unnecessary risk. Why take that chance?
