USING YOUR FINANCIAL STATEMENTS

The best cure for potential financial problems is fast action. Financial statements often tell a story that will enable you to act in time, if you periodically review your financial statements and if you understand what the figures are telling you. Here are some things to look for when analyzing your financial statements.

1. Deterioration in cash position -This may be a drop in dollar levels or in the percentage of cash to total assets. It is often accompanied by marked changes in deposit activity, including overdrafts, draws on uncollected funds, more frequent deposits, deposits of smaller value checks, and declining average monthly balances.

2. Slowdown in the receivables collection period - A slowdown points to an owner who has become liberal with credit policies or gotten lax in collecting from his credit customers.

3. Changes in credit and sales philosophies - Installments sales may have replaced more strict credit terms. Finance or lease arrangements may have been allowed; these may seem attractive, but small firms should avoid them.

4. Sharp increases in the dollar amounts of accounts receivable or as a percentage of total assets - A request for a receivables aging may show substantial past due accounts with a few customers, or worse, with a single customer. Where such customers are of questionable financial strength, the risk becomes undesirably high.

5. Noticeably rising inventory levels, in dollar amount or as a percentage of total assets - These increases, often supported by suppliers, can be very risky. They may also be related to the borrowers reluctance to liquidate excessive or obsolete goods at a reduced price. This is often accompanied by a
   reduction in inventory turnover. This may reveal overbuying or some other imbalance in the company's purchasing policies. Often it indicates that slow-moving items are not being dealt with properly. Determining how long items have been in inventory may help you determine the reason for the slowdown in inventory turnover.

6. Major changes in the concentrations in fixed assets - Funds needed to purchase fixed assets may be being used for other things. This creates problems in times of rising costs when future replacement, renovation, and remodeling may seriously drain cash or necessitate large amounts of long-term debt. Rising concentration of fixed assets can be a serious problem when achieved at the expense of other asset needs. Levels well above industry norms are an added indicator of potential trouble. Also significant is the related rise in funded debt to support such acquisitions, especially when the company has committed a sizable portion of its future earnings to pay for them.

7. Disproportionate rise in debt levels - The element of risk is always greater when the rise is concentrated in trade debt or the rise is in "friendly debt" (monies due officers and stockholders) or when there is no corresponding increase in the levels of assets. Substantial increases in long term debt is serious when repayment must depend upon a flow of funds that represent the bulk of anticipated earnings over many years. A less-than-satisfactory historical earnings record makes such commitments even more dangerous.

8. Rising cost percentages - A 1% cost increase on $1 million in sales represents a decrease of $10,000 in pretax profit. When the cost increase comes in cost of goods sold, it may reflect the borrowers inability or unwillingness to pass higher costs along to customers. When it appears in the operating area, it may reflect a loss of control over some segment of general, selling, or administrative expenses.

9. Rising level of total assets in relation to sales - No one questions the fact that when you do more business, you normally require a higher level of inventory, carry greater receivables, and need more fixed assets. The time to raise questions is when assets rise much faster than sales growth warrants. If they do, its usually the creditors who end up financing the higher asset levels simply because the business is not paying its way with higher profits.

10. Rising level of total assets in relation to profits - The real investment of any business is represented by its assets rather than its capital. Even if a portion of these assets is debt supported, the fact remains that the company is obligated to pay those debts. The assets exist solely to add to earnings; it is a sign of failing performance when they earn increasingly less in relation to their size.

If the concepts discussed here are difficult for you to grasp, enlist the aid of your SCORE Management Counselor or your CPA to explain and clarify the use of your financial statements as a major factor in the successful management of your business.