How to analyze and report your financial results?

You’d be surprised how many entrepreneurs don’t really understand the finances of their business. Yes, they make them out of Fresh Books or Xero, and they’re most likely targeting high-level numbers like total revenue and total profit. But they don’t dissect everything in between. And more often than not, when it comes to managing your company’s finances, the devil is in the details. This post will help you learn the basics of formatting, interpreting and reporting your financial data so that you look like a pro to your investors or whoever asks for it.

The most important financial statements

There are typically three financial statements that are prepared: (i) the income statement (or often referred to as the income statement); (ii) the balance sheet; and (iii) the cash flow statement. The income statement measures all of the company’s incoming income and outgoing expenses, for whatever period of time you choose to study. This is the most studied financial statement as all companies aim to grow their revenues and profits over time. The balance sheet lists all assets, liabilities and equity in the company at any point in time. As the name suggests, asset values ​​must be in balance with liabilities and equity values. The cash flow statement gives you a good idea of ​​how your balance sheet cash balance is moving up and down with any operating, financing or investing activities that may not be completely clear from the profit levels shown on the income statement. For example, the cash flow statement will be adjusted for non-cash expenses such as depreciation and show how cash was used except for paying expenses in the income statement.

Optimizing the income statement

For me, these are the most important numbers to study on the income statement: (i) income; (ii) gross profit margin (revenue less cost of goods sold); (iii) EBITDA (gross profit less all expenses resulting in profit before depreciation and amortization of interest taxes); (iv) return on advertising spend or ROAS (revenue divided by sales and marketing costs); and (v) return on employee expenses or ROSS (revenue divided by total payroll investment including salaries, bonuses, commissions and benefits). There may be others depending on your industry or business model, but these are some of the bigger ones that apply to almost all businesses.

Optimizing for revenue is pretty easy to understand – more is better than less!! The bigger the turnover, the better. So you are always trying to improve your earnings from the prior period, either the week before or the same week of the previous year if your business is seasonal.

Optimizing for gross profit means you want your gross profit margin (gross profit divided by sales) to improve, or at least stay the same over each future period. In other words, you want your cost of goods sold as a percentage of revenue to stay the same or improve. Rising costs will obviously hurt your net profit. And looking for opportunities to reduce your costs, whether with new suppliers or more efficient processes, will help you do this. Gross margins can vary wildly based on your business model, but often end up in the 20%-80% range, with most in the 30-40% range.

EBITDA is obviously benefited from improvements in revenue and gross profit, but it is also benefited by keeping all your other expenses the same as a percentage of revenue or improving over time. In terms of which expenses you should focus on optimizing – focus on the big ones. For most companies, these are usually sales and marketing costs and labor costs. Those should be clearly broken down as separate line items. The minor expenses can be grouped into “other expenses”, but they too should be optimized where possible. You’re doing well if dollar EBITDA grows and EBITDA margin (EBITDA divided by revenue) improves over time. It’s worth noting that some expenses are fixed one-time expenses (e.g. your CEO’s salary), so they will decrease as a percentage of growing revenue. And other costs are variable recurring costs that grow as you grow (e.g., shipping costs), which will most likely remain the same as a percentage of sales. So, know the differences here. EBITDA margins typically end in the 10-30% range, depending on your business model.

ROAS is probably the most important metric you manage. You cannot grow your revenue without increasing your sales and marketing investments. And you want to make sure you win new customers as cost-effectively as possible. ROAS usually comes out in the 3x to 10x range, and the higher the number, the more effective your ad investment is. It’s worth noting that it’s okay if your ROAS decreases slightly over time as you scale, as your initial marketing spend is typically invested more effectively than your widely used tactics. But it should always lead to a profitable return on marketing investments.

ROSS is another important metric to measure. It helps to measure whether your investment in human resources is maintaining or improving its efficiency over time. ROSS usually ends up in the 5x-10x range, depending on your business model.

Optimizing the balance

For me, the most important numbers to study on the balance sheet are: (i) cash; (ii) debt ratio (total debt divided by total debt plus invested equity); (iii) current ratio (current assets divided by current liabilities); (iv) inventory turnover ratio (cost of goods sold divided by average inventory); and (v) return on capital or ROC (net profit divided by total invested capital).

Optimizing for cash is pretty easy, more cash is better than less! You always want to have enough cash on hand to ensure you can manage your business needs for the next 12 months or more. If not, it may be time to consider financing or lowering your expenses and cash burn rate to extend your “lifeline”.

Debt is typically a bad thing for early stage businesses, given all the risks and uncertainties of a startup environment. And most small business debt comes with personal guarantees from the owners, which means that if the company can’t pay its debts, the individual owners roll back the liability and you could go out of business personally with any business shortcomings. But if you go into debt, never let your debt ratio exceed 50% of the invested capital. And seek asset-based funding sources that can secure your assets or inventories, without personal guarantees where possible.

Your current ratio basically measures whether your current assets exceed your current liabilities or not, and that there is no immediate need for cash to fund working capital needs. So never let this ratio fall below a 1:1 ratio, otherwise short-term capital may be needed to fund immediate obligations.

Your inventory turnover ratio measures how quickly you move products in and out of your warehouse. It is calculated based on your average inventory levels in the period studied, not necessarily the time balance on a specific date. The sooner you turn the stock, the better, to reduce your cash out-of-pocket investment in stock. I would say an average company flips the stock 3-4x a year. If you lose sales, you may need to write off inventory that isn’t selling or change your product and purchasing decisions to make the business more efficient.

Your ROC helps illustrate that you are giving your investors a good return on their investment. Depending on how big your company is and how fast you are growing, I would say that the ROC should be between 15% and 35% on average to attract and retain your investors.

Optimizing the cash flow statement

The cash flow statement is just another way to study your cash inflows and outflows, obviously not allowing you to spend more than you need to spend. But this statement helps your CFO know if cash has been spent or generated by operations (e.g. capital expenditure on replacement equipment); investing (for example, taking an equity interest in a supplier) or financing activities (for example, taking out a new equity investment in the company).

Reporting timing

For me, every company should study their business at least monthly. Larger companies tend to study their business on a weekly or even daily basis. But no less often than monthly. So, at the very least, when you reach the 1st day of a month, it’s time to study the financial results of the previous month.

Reporting analytics

In your financial statements, I would report results for: (i) the current month; and (ii) the period of the year to date. And I would compare them to; (i) the original budget; and (ii) the same results for the prior year period (for example, compared to November 2022 to November 2021). And the reports must include: (i) dollar amounts; (ii) percentages of sales; and (iii) percentage growth rates, for each line item. These reports should include each of the key data points and metrics discussed in this post so that you can track their progress over time and examine whether the company is doing better or worse than budget, and better or worse than last year, and to what extent.

Here are examples of column headings for your March income statement: (i) March dollars; (ii) March % of sales; (iii) March % increase; (iv) January to March YTD Dollars: (v) January to March YTD Percentage; and (vi) % increase from January to March.

Once the reports have been created, you or your CFO should now study the data and metrics and prepare a management discussion and analysis paper, discussing key trends and why the numbers are moving in the direction they are and why they are better or worse than last year or the plan. That “WHY” is the most important thing here, make sure you understand the reasons behind any moves in your results or stats so you can manage them accordingly. So build the monthly discipline to actually study this when allocating your time.

Closing Thoughts

I was a finance major in college, so analyzing financial statements is a pretty basic skill of mine. But if you’ve never studied finance, it can be a daunting exercise. So hopefully this post can point you in the right direction to really master the numbers of your business.

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George Deeb is a partner at Red Rocket Ventures and author of 101 Startup Lessons – An Entrepreneur’s Handbook.