Reading your own financial statements in fifteen minutes

Most owners receive financial statements and read the bottom line. That single number is the least informative figure in the document. Here is a sequence that takes about fifteen minutes and tells you considerably more.

Read them in this order

1. Revenue, against the same period last year

Not against budget, against the same period last year. Budgets are aspirations and comparing against one mostly measures how optimistic you were. Year-on-year tells you whether the business is actually growing.

Note the percentage, not the rupee change. Ten per cent on a larger base is a different business from ten per cent on a smaller one.

2. Gross margin percentage, against the same period last year

Gross profit divided by revenue. This is the single most diagnostic number in the statement.

If revenue grew and gross margin fell, you are buying growth, through discounting, through a worse product mix, or through input costs you have not passed on. That is a decision if it was deliberate and a problem if it was not. Most owners discover it was not.

3. Operating expenses as a percentage of revenue

In a healthy growing business this percentage falls slowly, because fixed costs spread over a larger base. If it is rising, overhead is growing faster than the business, which is the most common way a profitable company becomes unprofitable.

4. Receivables, expressed in days

Take closing receivables, divide by revenue for the period, multiply by the number of days in the period. That is roughly how long it takes to get paid.

Compare it with last year. If it has gone up by fifteen days, you have effectively lent your customers another fifteen days of revenue, and that money has to come from somewhere, usually your own working capital or an overdraft you are paying interest on.

This number moves before a cash problem arrives. It is the earliest warning in the statement.

5. Inventory days, if you hold stock

Same arithmetic, using cost of goods sold. Rising inventory days mean money is sitting on shelves. Sometimes that is a deliberate buffer; often it is slow-moving stock nobody has written down yet.

6. Cash, and the movement in it

Now look at the cash balance and how it moved over the period. Then hold it against the profit figure.

If you made a profit and cash fell, the money went somewhere, into receivables, into inventory, into repaying borrowing, into assets, or out as drawings. Find which. This one comparison explains more about a business than any other.

What this sequence is doing

It moves from the outside in: what you sold, what it cost, what it cost to run the place, and then whether any of it turned into money. By the time you reach the profit figure you already know the story behind it.

Two things to be sceptical about

Profit without a cash explanation. If profit is up and cash is down, ask why before congratulating anyone.

Any figure you cannot trace. If a line moved materially and nobody can explain it in one sentence, that is the line to examine.

If your statements do not let you do this

Some do not. If your accounts arrive months after the period, or the categories change between periods, or everything sits in one line called "expenses", the document is built for a filing requirement rather than for you.

That is fixable, and it is usually a chart-of-accounts problem rather than an accounting one.