Making Sense: Financial Statements and KPIs
Creating financial statements seems straightforward, and for those with the right education and experience, it is. The three main statements are:
- The Profit and Loss Statement – Revenue less costs.
- The Cash Flow Statement – Incoming and outgoing cash, and what is left on hand.
- The Balance Sheet – What is owned and owed at a point in time.
But what are these sheets of numbers indicating? What can be taken from them and turned into value-added action?
A Snapshot in Time
First, the statements will show where the business is at a point in time. Financial ratios, or metrics, such as the gross margin, net margin, debt to equity ratio, and many more can be extracted from the statement information. The CFO can then look at these ratios and determine what’s going well, and what is not. This is not done in a box. Questions must be asked. “What have these ratios been historically?” “How do these numbers compare to the competition?” “What past or current factors are contributing to these numbers?”
The CFO will also determine which ratios are the Key Performance Indicators (KPIs) for the company. Which numbers are KEY varies from company to company, and some don’t appear on the financial statements, and require further analysis of related information. These include things like the ROI on specific marketing activities, click through rates on the company website, and customer retention rates.
The ratios given the most attention should be the ones that measure the key drivers of the business. Most businesses rely solely on the monthly accounting reports that track the basics without looking at the specific KPIs that are having the most impact on the bottom line. It takes detailed analysis to determine what metrics indicate if the business in on the right track to achieve its short and long-term goals.
Next, the CFO will strategically determine what can be done to solve indicated problems and improve the KPIs to put the company in a better current and future position. Some solutions and actions are reasonably simple. Unnecessary costs can be eliminated or reduced, cash flow can be improved by better accounts receivable, accounts payable, and inventory management, and perhaps debt can be refinanced, therefore reducing the debt service and freeing up cash. Other solutions require further information and analysis. Here, understanding the whole business and its model becomes critical. For example, is the company offering a product or service that is positioned as a low-cost option, or is their offering a superior product or service that commands a higher price? That will help the CFO determine if the pricing structure is correct, and if the cost structure of the company is correct. This will require developing a financial model, based on many internal and external factors.
Another example is more micro. Which customers are most (or at all) profitable? The business will undoubtedly have customers who are repeat customers, who make referrals, and require little maintenance. Other customers will buy, and then require too many customer service hours, and therefore are a cost that reduce the bottom line.
The list of factors to be analyzed is many. This analytical function is one of the key values added by a CFO. This is summarized well by Joe Lordon of FocusCFO. “A CFO should provide sound financial analysis, develop solutions to business challenges, and effectively communicate financial concepts and related issues within the organization.”