How to Read Financial Statements

By Merle T. Northrop, Flatiron Ventures, Inc.

Part 2 of 3 – The Income Statement

Merle Northrop

Moving on from the Balance Sheet (featured in the previous issue of NewsLeaf), go to the Income Statement. Always review comparative statements for both the Balance Sheet and Income Statement. Compare your year-to-date to last year. How have the numbers changed? What are the differences? First look for big dollar differences then look at big percentage differences. Be sure income and expenses are properly categorized and not in a different account from one year to the next. It’s important to compare apples to apples! 

Once you and your accountant/bookkeeper have made any corrections needed and the statements are truly comparable, then start what I call comparing “dollars” to “things.” Look at: Gross Revenue to the number of full-time equivalent employees; payroll dollars to employees; Gross Revenue to sales days in the period covered; Gross Revenue per unit sold; Percentage Gross Margin compared to a theoretical margin you expect (by taking a sampling of products and compare that margin to actual); Average sales per customer sale, and so on.

When reviewing the financial statements, look first at the big expense items. For those using QuickBooks, when setting up the chart of accounts, the program defaults to an alphabetical listing, which is not my preference for multiple reasons. Although alphabetical listing simplifies the chart of accounts setup, it doesn’t provide as good a guide to analysis of the business. There are some fixed expenses that “just are” and can’t be impacted, like rent, phone and utilities. However, there are several categories with similar purposes that can be shown together. Some expense groups need close monitoring, but if listed alphabetically, the reviewer can miss some relationships that need close attention.

My approach to setting up a chart of accounts is to create perhaps half a dozen of what I call, “Parent Accounts” under which the actual accounts used fall into. Not all of these are always used, but some Parent Accounts I like to use include marketing, staff, facilities, equipment, administrative, and maybe some others unique to your business. I also believe that every business has a “Critical Factor.” The Critical Factor is a single number that is easy to track and is a fairly accurate indicator of business activity. Perhaps it’s the number of customers that walk in the door, the number of service stops each day, the number of loads of topsoil or sod delivered each day, or number of phone calls or online orders per day. Of course, tracking the number means that you have to count it! Nearly every business has a fairly simple-to-find number that is a reasonable indicator of how the business is doing. Find that factor and watch it daily and weekly.

Merle T. Northrop

Flatiron Ventures, Inc.
1600 38th St., Suite 203
Boulder,  CO  80301 303-440-6141

Next Issue – Part 3