Each of the components of your financial statements provides unique information; however, they must be assessed together to get a complete picture of a company. The balance sheet shows the financial position at a point in time, the income statement demonstrates the company’s ability to manage expenses and revenues (if you are far enough along to have revenues), and the statement of cash flows shows which activities used and/or produced cash during the year.
You can gather useful information by looking at the statements separately, but they’re even better together. By comparing net income to net cash inflows, you can determine if revenue and expenses recorded on the income statement provide or use cash. If the net cash inflow/outflow is significantly different from net income/loss, this might indicate that the company has significant non-cash revenues or expenses. For example, large up-front payments on a SaaS contract could provide cash but little revenue in the beginning (thus there may be more revenue on the income statement in the future, but no cash inflow to support it).
There are many ratios that can be applied to financial statement amounts to paint a picture of the health of the company’s operations. Accounts receivable turnover, which is calculated by dividing net sales by the average receivable balance over the period, and then dividing by 365, provides the number of days, on average, that it takes the company to collect a receivable. A higher number might indicate that the company needs to improve their collection process. A startup or early stage company is often focused on the burn rate. This is calculated by dividing the operating cash outflow (net cash used by operations in the statement of cash flows) plus cash outflows for certain capitalized costs by 12 to get a monthly burn rate. The burn rate is then compared to cash on hand to determine when additional capital is needed.
Whether using one of these financial statement ratios or any of the many others, it is important to look at all of the financial statements together to see the big picture.
For more information on how you can use your financial statements to more effectively manage your business, please contact your Aronson advisor or Danielle Meyer at 301.231.6200.
About the Author: Danielle Meyer is a manager in Aronson LLC’s Technology Industry Services Group, where she provides comprehensive audit and accounting services to a diverse group of companies operating in the high tech, biotechnology/life sciences, e-commerce and software sectors.