6 Principles to Make Your Financial Statements Make Sense?

Business success is measured in terms of producing predictable and consistent profitability? Profit is the result of Revenue exceeding Expenses. All you need is to sell a product or service at a price greater than the cost of designing, producing, marketing, selling, delivering and servicing that product or service every day, day-in and day-out. This sounds pretty straightforward doesn’t it! Financial statements such as the Income (P/L), Balance Sheet and Cash Flow are commonly used to record the financial dealings of your company for the most recent accounting period. Providing they are prepared accurately do they make sense and can they help you managed the company toward predictable and consistent success in the current and future accounting periods?

If you have the right number at the bottom of the P/L then you might not care what the other numbers mean or if they make sense – until the next reporting period when the wrong number appears and you can’t figure out what went wrong. Even a good Profit number should be understood so that you are sure that the right business practices are in use. In addiiton, that you are not just experiencing a positive anomaly or windfall that could become a nightmare when the correction occurs in the next period.

Here are six principles used by successful companies that you can apply to manage your financial process more effectively and therefore increase the effectiveness in managing your company.

  • Define P/L Components and Assign them to Key Management
    • Identify the variable cost factors of your business that influence your bottom line.
    • Establish either absolute numbers or ratios (i.e. a function of sales level, labor hours, etc.) that must be observed for each component.
    • Establish the data collection and review cycle for each component.
    • Assign responsibility and accountability for the P/L component to a key manager (see example below).
  • Budget compliance
    • Good financial management is based upon operating with a budget prepared to support a revenue forecast or production plan.
    • Adjustments to budget (down or up) can be made as the actual forecast is realized.
  • Observing cutoffs
    • Cutoffs for all paperwork insure the timely processing of critical transactions that affect the financial record keeping of the business.
    • Missing accouinting cycle cutoffs (processing invoices, submitting timecards, recording material receipts, recording work-in-process) can result in over or under stating performance in a financial period that will adversely affect your ability to make appropriate decisions for the business.
  • Accurate Coding of Transactions
    • Not only do transactions need to be processed timely but they need to be coded correctly to make sure that the activity is recorded and applied to the right activity so tht it can be managed by the right management group.
  • Timely and Predictable Review Cycles
    • Monthly reviews that occur infrequently or on inconsistent dates of the month will erode the financial discipline that needs to be placed on the financial process on a daily basis.
    • Enforce a regular review cycle complete with follow up on corrective actions.
  • Take Corrective Action
    • Effective financial management is not a static or passive activity.
    • A proactive attitude toward processing feedback from P/L components (i.e. inventory levels, labor efficiency, commissions or discounts) during the period will often allow you to take action to offset an unexpected event and minimize or avoid an impact on your current period financial performance.

Using your financial reporting system to effectively manage your company requires that you adopt core disciplines that must be reinforced on a regular basis. Daily business activity will provide many opportunities to “bend” the rules and make exceptions. The adoption of a strong financial management policy by key managers and line supervisors will make the difference in how effectively your core financial discipline is complied with. As the owner, CEO or senior decision maker it is your leadership job to ensure that this discipline becomes a corner stone attitude in your company culture.

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