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Articles From Lumsden McCormick

Close-Up On Financial Statements

There are three types of financial statements under U.S. Generally Accepted Accounting Principles (GAAP). Each one reveals different, but equally important, information about your company’s financial performance. And, together, they can be analyzed to help owners, management, lenders and investors make informed business decisions.

Profit or Loss

The income statement shows revenue and expenses over the accounting period. A commonly used term when discussing income statements is “net income,“ which is the income remaining after all expenses (including taxes) have been paid.

It’s also important to check out the company’s “gross profit.“ This is the income earned after subtracting the cost of goods sold from revenue. Cost of goods sold includes the cost of direct labor and materials, as well as any manufacturing overhead costs required to make a product.

The income statement also lists sales, general and administrative (SG&A) expenses. They reflect functions, such as marketing and payroll, that support a company’s production of products or services. Often, SG&A costs are relatively fixed, no matter how well your business is doing. Compute the ratio of SG&A costs to revenue. If the percentage increases over time, business may be slowing down.

Financial Position

The balance sheet tallies your company’s assets, liabilities and net worth to create a snapshot of its financial health on the financial statement date. Assets are customarily listed in order of liquidity. Current assets (such as accounts receivable) are expected to be converted into cash within a year, while long-term assets (such as plant and equipment) will be used to generate revenue beyond the next 12 months.

Similarly, liabilities are listed in order of maturity. Current liabilities (such as accounts payable) come due within a year, while long-term liabilities are payment obligations that extend beyond the current year.

Because the balance sheet must balance, assets must equal liabilities plus net worth. So, net worth is the extent to which assets exceed liabilities. It may signal financial distress if your net worth is negative. Other red flags include:

   - Current assets that grow faster than sales, and
   - A deteriorating ratio of current assets to current liabilities.

These trends could indicate that management is managing working capital less efficiently than in prior periods.

Cash Inflows and Outflows

The statement of cash flows shows all the cash flowing in and out of your company during the accounting period. For example, your company may have cash inflows from selling products, borrowing, and selling stock. Outflows may result from paying expenses, investing in capital equipment and repaying debt.

The statement of cash flows is organized into three sections: cash flows from operating, financing and investing activities. Ideally, a company will generate enough cash from operations to cover its expenses. If not, it may need to borrow money or sell stock to survive.

Ratios and Trends

The most successful businesses continually monitor ratios and trends revealed in their financial statements. Contact us if you need help interpreting your financial results.

© 2019

Close-Up On Financial Statements

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Doug is a principal in Lumsden McCormick’s accounting and auditing department and has been with the Firm since 2008. Prior to joining the Firm, he worked at KPMG for three years. Doug is responsible for the supervision of staff and planning and completion of client engagements including audits, reviews, compilations, and other bookkeeping and consulting engagements. He has prepared financial statements, coordinated and reviewed work performed by internal auditors, and presented audit findings to management. Doug has experience providing services to financial institutions, workers’ compensation trusts, employee benefit plans, and other commercial businesses, including those in manufacturing, construction, and general service industries. Additionally, he has experience working on SEC engagements. Doug is a member of the Firm’s recruiting team and chairs the Firm’s Accounting & Auditing Technical Committee.

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