Using Financial Statements to Measure Financial Health

...they tell three different but related stories about how well your company is doing financially.


The three financial statements offer three different perspectives on your companies financial performance. That is, they tell three different but related stories about how well your company is doing financially.

• The income statement shows the bottom line: it indicates how much profit or loss a company generates over a period of time.
• The balance sheet shows a company's financial position at a specific point in time. That is, it gives a snapshot of the company's financial situation--its assets, liabilities, and equity--on a given day
• The cash flow statement tells where the company's cash comes form and where it goes--in other words, the flow of cash in, through, and out of the company.

Another way to understand the interrelationships is as follows:

• The income statement tells you whether your company is making a profit
• The balance sheet tells you how efficiently the company is utilizing its assets and how well it is managing its liabilities in pursuit of profits.
• The cash flow statement tells you whether the company is turning profits into cash.

ACTION POINT: Understand your companies health through the lens of the three key financial statements.

The Balance Sheet

companies prepare balance sheets as a means of summarizing their financial positions at a given point in time.


Most people go to a doctor once a year to get a checkup--a snapshot of their physical well-being at a particular time. Similarly, companies prepare balance sheets as a means of summarizing their financial positions at a given point in time.


Assets = liabilities + owner's equity


Assets are the things a company invests in so that it can conduct business--examples include financial instruments, land, buildings, and equipment. in order to acquire necessary assets, a company often borrows money from others or makes promises to pay others. That money, which is owed to creditors, is called liabilities. Owners equity, also know as shareholders' equity, includes the capital that investors have provided and the profits retained by the company over time. If a company has $3 million in assets and $2 million in liabilities, it would have owners' equity of $1 million.


Assets = liabilities + owner's equity
$3MM = $2MM + $1MM


By contrast, a company with $3MM in assets and $4MM in liabilities would have negative equity of $1MM--and serious problems as well.


Thus, the balance sheet provides a description of how much, and where, the company has invested (its assets)--broken down into how much of this money comes from creditors (liabilities) and how much comes from stockholders (equity). Moreover, the balance sheet gives you an idea of how efficiently your company is utilizing its assets and how well it is managing its liabilities.


Balance sheet data is most helpful when it's compared with information from a previous year. The balance sheet begins by listing the assets that are the most easily converted to cash: cash on hand, receivables, and inventory. These are called current assets.


Next, the balance sheet tallies other assets that have value but are tougher to convert to cash--for example, buildings and equipment. These are called fixed or long term assets.


Since most long-term assets, except land, depreciate over time, the company must also include accumulated depreciating in this part of the calculation. Gross property, plan, and equipment minus accumulated depreciation equals the current book value of property, plant, and equipment.


Subtracting current liabilities form current assets gives you the company's working capital. Working capital gives you an idea of how much money the company has tied up in operating activities. Just how much is adequate for the company depends on the industry and the company's plans.


Most long term liabilities are loans.


Owner's equity comprises retained earnings (net profits that accumulate in a company after any dividends are paid) and contributed capital (capital received in exchange for stock).



ACTION POINT: Become familiar with the key components of the balance sheet to evaluate the health of your organization.

Understanding Financial Statements

But it is pretty to see what money can do. --Samuel Pepys

Companies do many things: build cars, process data, provide services, and even launch satellites. But the underlying purpose for all for-profit companies is to make money. As a for-
profit manager, your job is to help the company make money--preferably, more money each year. Even if you work in the nonprofit or government sectors, where net income is neither the only nor the most important bottom line, it is still vital that you carefully monitor how much money comes in and where it gets spent.

You can help your company make money by reducing costs, increasing revenues, or both. You can also help the organization be financially successful by making good investments and using its assets to their fullest extent. The best managers don't just mind the budget--they look for the right combination of controlling costs, improving sales, and utilizing assets.

How's your company's financial health? Where does its revenue come form, and where does it spend its money? How much profit is it making? Where is its cash coming form, and where is it going to? Companies provide answers to such questions in three documents, called financial statements: the income statement, the balance sheet, and the cash flow statement.

ACTION POINT: Consider the questions above to evaluate your organizations health.

Why Understand Finance?

...it will explain what you need to know to be an intelligent consumer of financial concepts in making business decisions.

No matter where you work in your organization, understanding basic financial concepts will help you do your job better and contribute to your company’s efforts to stay in business and turn a profit.

Understanding Finance explains the basics of this important subject. It will not into make you a finance expert, nor will it qualify you to become a financial analyst, controller, or chief financial officer. But it will explain what you need to know to be an intelligent consumer of financial concepts in making business decisions.

Reduced to its essentials, business finance is about acquiring and allocating the resources a company needs to operate. Regarding resource acquisition, finance is concerned with questions such as:

• How will our company acquire and finance its inventory, equipment, and other physical assets?

• Should we use the owner’s money, borrowed funds, or internally generated cash for resources acquisitions?

• How long does it take to collect money owed to us by customers?

And regarding resource allocation, finance helps mangers answer questions like:

• If we could invest in several ventures, how might we determine which would ultimately generate the greatest value?

• What return must an investment produce to be worth making? And how should we measure return?

• How can we determine the profitability of our company’s different offerings?

Sometimes finance is also part of a company’s information system along with accounting, to produce financial statements, budgets, and forecasts. These documents give you the numbers your need to ask key questions and to make savvy decisions for your own division, department, or team if you interpret and use them correctly.

ACTION POINT: Understand finance from the perspective of resource acquisition and allocation.