It’s all Greek to me!
Is that how you feel when you’re learning how to read financial statements? If you aren’t well-versed in financial terminology, then it can feel like you’ve stepped onto another planet when you’re reviewing your important paperwork.
But don’t get lost in the thick of things. Continue reading this article and we’ll help you cut through the jargon with these simple tips.
1. Understanding Your Balance Sheet
The balance sheet tells you what assets you have. You’re able to see what assets you have by adding liabilities to the owners’ equity. Keep in mind that your balance sheet rolls forward from year to year.
Using the balance sheet, you’re able to see what you have, what you owe, and what’s left over.
The more frequently you review your balance sheet, the better. As you get familiar with the balance sheet, you’ll be able to see when good trends are happening and when things are headed south.
When you see current assets listed on your balance sheet, these are assets that you can easily access. Usually, these assets are cash or can be converted to cash within the fiscal year.
The current liabilities you see on your balance sheet mean the things you owe short-term and these must be paid within the year.
2. Understanding Your Profit & Loss Statement
You likely look at your profit and loss statement a lot more than you look at your balance sheet. While your profit and loss statement is helpful, it isn’t as telling as your balance sheet since it doesn’t roll forward from year to year.
At the beginning of the year, your profit and loss statement starts out at zero.
When you’re reading your profit and loss statement, look for trends. You can compare different time periods and you’ll be able to get different views of what’s going on.
For instance, if you notice that your sales are increasing but your profits are decreasing, you need to figure out how to increase profit margins.
Are your costs of goods sold (COGS) going up? If you notice your COGS is going up, you need to see if this is happening throughout your industry or if you need to look for a more competitive supplier.
Keeping a watch on your profit and loss statement will allow you to make informed decisions so you can increase your profits in ways that won’t harm your business.
3. Understanding Cash Flow
Looking at your cash flow statement lets you know whether your business has enough cash flow to keep floating.
When you look at your cash flow statement, you’ll notice there are three different sections. These sections are:
- Operating
- Investing
- Financing
Keeping a close eye on your cash flow and understanding what you need to do to keep it moving will make sure that you don’t fall into unnecessary hardship in your business.
A couple of helpful ratios to pay attention to and run on a regular basis are as follows.
Operating cash flow divided by net sales: when you know this information, you know how much cash you get for each dollar of sales. The higher this percentage is, the better for your business.
Free cash flow equals cash flow provided by operating activities minus capital expenditures: when you know these numbers, you’ll be able to see how much cash is left from its operations after paying for all the company’s capital expenditures.
Financial Terms Every Newbie Needs to Know
Now that you know more about reading your financial statement, you’re still likely to hear some interesting jargon that you can’t quite interpret. Here are some of the terms you need to understand to make your financial life easier.
- Net income: To break it down to the very basic understanding of net income, this is your company’s total profit. You get your net income by subtracting all your company’s expenses from its revenue.
- EBITDA: EBITDA stands for “earnings before interest, tax, depreciation, and amortization.” To get this number, subtract operating expenses from revenue and then add back depreciation and amortization to operating profit.
- GAAP: GAAP stands for “generally accepted accounting principles” and is meant to standardize financial statements and keep reporting consistent.
- EPS: EPS stands for “earnings per share.” When companies do an earnings announcement, EPS is one of the things that’s often highlighted. EPS helps investors understand the company’s earning health a little better and after an announcement, you may notice that the stock prices change because of it.
These are just a few of the most common financial terms you’re likely to come up against as you’re speaking with financial professionals or reading stock financial statements and finance sections of your favorite news report.
Continue to grow your knowledge of financial terms, but also consider having a professional such as a CPA on your side if you’re confused about your financial situation.
Now You Know How to Read Financial Statements
Now that you have these simple tips on your side, you know how to read financial statements with the best of them. Even though you feel more confident with your financial understanding now, you might want the help of a professional.
If you feel it’s time to contact a professional to help you with your financial statements and other issues relating to finances, contact us. We offer a free, no-hassle consultation, so make sure to reach out right away to get the help you need.
