Understanding Financial Statements
“Understanding a financial statement is important for establishing a line of credit with distributors,” he said.
Alpert listed the following 10 things that contractors should know about financial statements.
1. Financial statements aren’t just for your accountants. Putting the right information in the statement and understanding that information is imperative for survival in business. “Income statements, along with balance sheets, are the most basic elements required by potential lenders, such as banks, investors and vendors,” Alpert said.
2. You must review your financial position regularly. “If financial statements are your scorecard, do you only look at the end of the game or do you check the score after each inning, period or quarter?” Alpert asked. He added that it is important to choose between a fiscal and calendar year and receive monthly P&L (profit and loss) statements.
3. Make sure your financial statements have the prior year’s statements for comparison. Budgets can be determined by analyzing prior statements.
4. Departmentalize your financials (e.g., installation, service departments). “You may be making a lot of money in one department and losing money in another, and are unaware of it,” Alpert said.
5. Maintain an accurate balance sheet. Alpert said, “The balance sheet is a frozen snapshot in time of everything you own and claims you have. One mistake is saying, ‘I’m doing well because I have money in my checking account.’” He added that a balance sheet must balance — assets must equal claims on assets.
6. Maintain an accurate income statement. This is the summary of a company’s profit or loss during any one given time period. “The shorter the time period, the better it is to analyze your income statement,” Alpert noted. “You use an income statement to track revenues and expenses so that you can determine the operating performance of your business over a period of time.”
7. Use financial data to determine pricing. Alpert said that the numbers need to add up, “Sometimes it is in your best interest to walk away from a job if you can’t make the margins you set for yourself.”
8. Learn what your break-even point is. It is defined as fixed costs/gross margin percentage, where fixed costs are recurring monthly expenses that do not vary with sales; and gross margin percentage of a product means its profit divided by its price. “You can figure what you have to do each month to keep the lights on,” Alpert said.
9. Learn the basic ratios. Alpert referred to three types of ratios: solvency (used to measure the financial soundness of a business and how well it can satisfy obligations), efficiency (used to measure the quality of a company’s receivables and how efficiently it utilizes its other assets), and profitability (used to measure how well the company performs). “Solvency ratios can be important if something happens to your business and you need to shift your inventory into cash,” Alpert said.
10. Don’t be afraid to ask questions.
Publication date: 06/23/2003