What do you do with your financial statements after your CPA delivers them? If you’re like most business owners and managers, you breathe a sigh of relief that they’re finished, file them away and go back to running the business. But financial statements can be a useful tool to help improve business operations in the future.
The income statement is a good starting point for using your financials to analyze performance and remedy inefficiencies and anomalies. Here are four ratios you can compute from income statement data:
Profitability ratios can be used to compare your company’s performance over time and against industry norms.
If your company’s profitability ratios have deteriorated compared to last year or industry norms, it’s important to find the cause. If the whole industry is suffering, the decline is likely part of a macroeconomic trend. If the industry is healthy, yet your company’s margins are falling, it’s time to determine the cause and then take corrective measures.
Depending on the source of the problem, you might need to cut costs, lay off unproductive workers, automate certain business functions, eliminate unprofitable segments or product lines, raise prices — or possibly even investigate for fraud. For instance, a hypothetical manufacturer might discover that the reason its gross margin has fallen is rising materials costs because its procurement manager is colluding with a supplier in a kickback scam.
Today’s uncertain, inflationary markets are putting the squeeze on profits in many sectors. But don’t accept that excuse without first investigating further. Your income statement provides critical clues into what’s happening at your company.
Examine the main components — gross revenue, cost of sales, and selling and administrative costs — to assess if specific line items have fallen due to company-specific or industrywide trends. Also, monitor comparable public companies, trade publications and the internet for information. We can help you determine possible causes and brainstorm ways to unplug your profit drains.