Our top 6 steps to understanding financial statement

Being able to understand the financial statements generated for your business is crucial, especially in unsettling and uncertain times. This will provide you with essential data when it comes to the current financial health of the business and what risks and opportunities might lay ahead.

1. Value chain analysis

The first step required is all about context. Identify the chain of steps involved in what the business makes or provides to customers, from creation to distribution.

2. Look at what is on offer

It’s essential to get perspective on the business offering. This will include current profit margins and the USP of the business and the product or service. You’ll need to be able to identify factors such as brand awareness and commitment among customers, as well as cost control, supply chain and geographic reach.

3. Review the structure of the statements themselves

At this stage you’re looking to understand whether the statements are well constructed and offer all the necessary information. For example, does the balance sheet provide an accurate overview of the business’ financial state? Does the income statement give you all the information that you need when it comes to economic performance? And when you’re looking at the cash flow are you able to clearly see where cash came into the business and where it went out and how liquidity within the business has changed over time as a result?

4. The analysis stage

Financial statements really come into their own with respect to making decisions about the future of business and planning strategy. This can involve some key analysis, including looking at how profitable the business is relative to its assets and how profitable it seems to key stakeholders such as shareholders. Financial statement ratios such as asset management, debt management/coverage, risk/market valuation and liquidity are all going to be essential when it comes to taking the information in financial statements and converting it into analysis that can be productively used.

5. The forecasting element

It’s often difficult to take existing data and turn it into a prediction for the business in the future but this is also an essential part of strong ongoing management. Making assumptions about the future of the organisation like this – in the context of the industry in which it operates – will steer decisions made for both cash flow and funding so it’s key that they are based on strong data and sensible forecasting.

6. Establish a valuation approach

Being able to value the business is essential, and not just in a situation where it is about to be sold on. There are a number of different approaches available when it comes to valuation, from a discounted cash flow methodology to accounting-based or relative valuation strategy. Financial statements offer key insight into the way that the business is performing and the potential that it has for the future. Understanding them is the first step towards being able to use this data to make a positive difference. Find out more by booking onto our Interpreting Financial Statements training course...