Financial literacy in today’s economic climate is more than just receiving reconciled accounts in periodic financial statements from your accounting firm. It is the ability to know where you are today, where you are going, and the plan to achieve it. To achieve your goals, you need to invest in a system, process and an advisor who can relay knowledge to you in a way that is easy to understand. This will allow you to change direction, set measurable goals and celebrate your successes.
Understanding the Relationships in Your Financial Statements
Business owners often get caught in the weeds and believe the way to solve a problem is by digging deeper into the soil. Have you ever paused to look at the key financial drivers that are causing the problem? Understanding the underlying problem and the impact it is having on your business is key. A skilled accounting firm has the ability to educate you on the meaning behind the numbers reported in your financial statements.
Accounting is based on a double entry system, meaning we must have a debit and credit that are in balance. You can also think of accounting as the study of financial relationships, meaning as we debit one account, we have a corresponding credit in another. To provide meaning we need to understand the relationships. Your financial statements are simply the summation of your transactions for a given period. By taking these financial statements and using ratios or non-financial data, you can begin to unravel the context behind these relationships – allowing you the opportunity to transform your business.
Here’s an Example
In the restaurant industry the key components of cost of goods sold includes food, beverage, paper goods and labor costs. The summation of these costs is also referred to as the prime costs. Often, your financial statements may report these costs on one line called cost of goods sold. By performing a simple ratio such as cost of goods sold divided by sales, we can determine how efficiently we are utilizing our resources to generate sales. By benchmarking this ratio month after month, we can begin to identify changes in the ratio that may need to be investigated. The benchmarking can be against your own data but should also be compared against industry data to better evaluate how you are performing.
To bring even more meaning to the relationships within cost of goods sold, you will need to investigate costs in more detail. One way to do this is to extract data on your costs individually such as having a food cost percentage to sales along with separate calculations on beverage, paper goods and labor. As these ratios fluctuate over time, you can determine the reason why and how it may affect your future selling prices. The outcome of this analysis may lead you to raise prices, change a supplier or review labor schedules.
You can also track non-financial data such as number of patrons served, number of hours open, and facility square footage. When comparing the non-financial data to sales we can get average sales per patron, per hour and per square foot. These averages can be compared over a period of time to gain an understanding of changes in your business or peak times for your business. This information in turn can be used to schedule your workers, order inventory or even adjust your restaurant hours.
The Role of Your Accountant
Your accountant can provide significant value by educating you on ratio and non-financial data to help you analyze your financial statements and guide you in discussing the efficiency of your business, forecasting operating results and providing the strategic direction for your business. We often refer to these tools as key performance indicators (KPIs). By tracking KPIs on a regular basis and keeping ongoing communication with your accountant, you can begin to understand the relationships in your financial statements. This understanding will provide you the ability to make decisions in your business that will allow you to track the realization of your strategic goals.
If you are not already having these discussions with your accountant, now is the time to tap into the value they can provide. As you begin the new year, we recommend identifying KPIs to track. Please contact Cray Kaiser today if you would like to discuss your financial reports.