4 Commonly Ignored Financial Reports
The coronavirus has put a strain on businesses in every industry. As McKinsey explains: “The timeline for companies to react to the coronavirus has shrunk dramatically.” In order to adapt, you need accurate and timely information.
Which information is most useful?
The decision can be difficult, given the sheer volume of data you can generate from accounting software. If you don’t use the right information, you can make the wrong decision, or miss the opportunity to make positive change.
Here are four commonly ignored financial reports that can help you make better business decisions.
#1 – Using a Multi-Step Income Statement
A multi-step income statement separates income into operating and non-operating categories, and this information helps you understand what activities are driving company profit. A business should produce the vast majority of sales and profits from operating income.
Operating income is generated from the day-to-day activities of running your business. A furniture manufacturer, for example, buys raw materials, builds furniture, and ships goods to customers. Furniture sales generate operating income month after month.
While operating income is sustainable over time, non-operating income is unusual. Let’s assume that furniture manufacturer sells a piece of equipment for a gain. Selling assets is not the primary business, and the manufacturer may not sell another asset for years. Non-operating income is not sustainable, and an owner can’t rely on the income to generate a consistent profit.
Increasing sales is great, but you need to understand the profitability of each product that you sell.
#2 – Understanding Profit Margin and Sales Mix
Profit margin is defined as (profit / sales), and a business can change the sales mix of products to generate a higher overall profit. Generate a report that lists the profit margin on each product you sell, and that product’s contribution to the sales mix.
Here are the sales price, profit, and profit margin for two products:
|Child’s baseball glove
|0% profit margin ($4/$20)
|Adult baseball uniform
|15% profit margin ($45/$300)
Adult baseball uniform $300 price $45 profit 15% profit margin ($45/$300)
The uniform generates far more revenue, but less profit per dollar of sales. A retailer can increase the company-wide profit margin by selling more baseball gloves and fewer uniforms.
Keep in mind that the selling the uniform requires a much bigger investment in inventory, which ties up available cash. Businesses seek to balance the need to produce more revenue with the profit generated from each dollar of sales.
Sales mix is the percentage of total sales generated by a particular product. The goal is to change your marketing efforts and increase sales of products with higher profit margins. If the baseball glove is only 2% of total sales, try increasing the percentage.
#3 – Effectively Manage Debt
If you carry debt in your business, you may only think about making your monthly payments. However, a growing amount of debt can limit your financial options. You may not be able to start that new product line, if you’re carrying too much debt.
Use your accounting software to run a report listing the debt to equity ratio. Here’s the formula:
|(Total debt) / (company equity)
Equity is the total amount of money raised from investors to operate your business.
The ratio is used to analyze debt as a percentage of total equity. Let’s assume that a typical ratio for companies in your industry is 2-to-1, or $2 in debt for every $1 of equity issued. If your firm’s ratio climbs to 3-to-1 or 5-to-1, it may be a red flag that your total level of debt is not manageable.
You can reduce your debt load by reviewing your budget, and cutting some expenses. Use the savings to pay off debt faster.
#4 – Monitoring the Accounts Receivable Aging Report
No business can operate without a sufficient level of cash inflows, and you need to monitor and collect money owed by customers. Use the accounts receivable aging report to collect money faster.
The report combines the dollar amount of outstanding invoices based on the date they were issued. Typically, invoices 0 to 30 days are grouped together, followed by 31 to 60 days and 61 to 90 days.
Put a system in place to email customers after 30 days, and to call customers with invoices older than 60 days. If you have a procedure for following up on payments, you’ll collect receivables faster, and you won’t have to borrow money to operate your business.
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