Looking at the sales reports of your business is one way to determine how well the business is doing, but there are so many other ways to analyze the financial state of a business. If an accounting firm handles all your company's booking, they may give you financial statements each month. With these, you can learn more about your company's financial state if you know the proper steps to take, and here are two ways you can do this.
One important way to analyze financial statements is through horizontal analysis. Using this method requires having financial statements from several different periods. The periods could be different months or years, and you can use this method with income statements and balance sheets.
The best way to do this is to take the financial statements from two periods and begin comparing each set of numbers to find the percentage change. If you are using an income statement, you could start at the top with gross sales. Begin by subtracting the change from the first period to the second period. Once you have this amount, you must divide it by the amount of gross sales the first period and then multiply it times 100.
The answer to this will be the percentage of change, and hopefully it will be a positive change for the sales of your company. You can then do this for each amount on the income statement to determine the changes in each account. This will tell you where you are improving and will let you find areas that need improvement. It will also help you find out if you are meeting the goals you have in place.
A second way to analyze your company's performance through financial statements is through ratio analysis. Using ratios is a great way to see where your company stands and can also help you find areas where you could improve. Here are some of the ratios you can use:
The level of liquidity of a company is vital for its growth and performance, and it represents how quickly assets can be converted into cash. There are several good ratios to use for this purpose, including:
- Current ratio – This is the easiest ratio to calculate and it involves dividing the current assets by the current liabilities. Current assets are any assets that can be converted to cash in one year or less, and current liabilities are debts you will pay off within one year. If you use this ratio over several periods and can compare the answer, it is better to see a current ratio that is continuously increasing because higher numbers are better.
- Liquidity index – This ratio calculates the average number of days it takes to convert inventory and receivables into cash. It is harder to calculate this ratio than the current ratio, but it will reveal a lot about your company's liquidity. Lower answers for this are better because this means that your company is fairly liquid.
Leverage ratios are also important to calculate because they tell you if your company can pay its bills, or if the company relies on obtaining debt to pay the bills. Here are a couple ratios you can calculate for this:
- Debt to equity – This ratio shows how your business finances its assets. You calculate it by dividing the total liabilities of the business by the total amount of equity owned by the shareholders.
- Fixed charge coverage – You can calculate this ratio to find out how well your company is able to pay its fixed expenses. The formula for this is calculated by adding your company's earnings before interest and taxes to your fixed expenses before taxes. You must then divide this amount by the total of your fixed expenses before tax and the interest you pay.
There are dozens of other great ratios you can also use when analyzing your company's financial statements. To learn more, contact your accounting firm for accounting services.