How to Analyze Financial Statements with Example

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So you might be asking yourself, why did we do all of that? Seems like a lot of effort for just a couple of reports.

Well here’s the answer.

You cannot make good business decisions without good information. With these two reports, we now have accurate, well prepared, easy to understand financial information about our little bakery. Here’s what we now know:

  1. How much we sell
  2. How much we spend
  3. What we spend it on
  4. How much profit we make
  5. How much our assets are worth
  6. How much we owe other people
  7. How much the business owes us
  8. Now, imagine next year when we prepare our next set of financial reports. Then we’ll also know
  9. If our profit is increasing
  10. If our expenses are increasing
  11. If our asset values are increasing
  12. What we’re spending more money on
  13. What we’re spending less money on
  14. If our debt is increasing
  15. If the business is improving in terms of higher sales, higher profits and higher net worth

This is the whole reason we prepare financial information - to pinpoint the strengths and weaknesses of our business and see where we can improve. Every year corporations spend millions of dollars on accountants and consultants, seeking advice on how to improve their profits. And can you guess what these accountants and consultants use to base their advice on? Financial statements!

For a well-educated professional, a set of financial statements can tell them an incredible amount of information about a business. Just a profit and loss statement and a balance sheet are enough to generate an abundance of suggestions and ideas. Right now, I’m going to pretend to be a consultant for your bakery. Let’s see what I can come up with.

Financial Analysis Example

PROFIT AND LOSS STATEMENT FOR (NAME)’S BAKERY FOR THE PERIOD ENDED (TODAYS DATE)
Revenue    
Sales $7,000  
     
Total Revenue   $7,000
     
Less: Expenses    
     
Cake mix expense $3,000  
Telephone expense $300  
Repairs expense $50  
Interest expense $1,000  
Depreciation expense $400  
     
Total Expenses   $4,750
     
Net Profit   $2,250
Less taxation (30%)   $675
Net profit after tax   $1,575
BALANCE SHEET FOR (NAME)’S BAKERY AS AT (TODAYS DATE)
Assets     Liabilities    
Bank $21,650   Loan $9,000  
Computer $1,500   John’s Car Shop $3,000  
Oven $2,000   Taxation Payable $675  
iPhone $500        
Car less accumulated depreciation $2,600        
Total Assets   $28,250 Total Liabilities   $12,675
           
      Owner’s Equity    
      Owner’s Equity at start of year $15,000  
      Minus: Drawings $1,000  
      Plus: Net Profit After Tax $1,575  
      Owner’s Equity at year end   $15,575
           
Total   $28,250 Total   $28,250

Observation 1:
Enter the Account with Largest Expense
Are you sure?Yes No

Corect! Your largest expense is your raw materials – cake mix. It is 63% of your total expenses. It is 42% of your sales. This is very high. Perhaps review supplier options.
Try again  (Hint:Check the cake mix expense)

Observation 2:
Do you see advertising expense?YesNo

You are not spending any money on advertising. This could be the key to increasing your sales. A good way to begin advertising is to start with social media and then begin spending money on getting exposure in food magazines, websites and deal sites like Groupon.
Try again

Observation 3:
Do you see any wages?YesNo

You are not spending any money on wages. Why don’t you have staff? A key action in increasing your sales might be to start training staff to do some of your jobs for you, such as cleaning and returning phone calls. This allows you to concentrate on running and expanding the business.
Try again

Observation 4:
How much money is in bank?
Are you sure?Yes No

You are paying interest on your loan, yet you have $21,650 sitting in the bank. You are paying interest for no reason. Had you paid the loan off and avoided your interest expense this year, your net profit would have increased by almost 50%. Pay off the loan, you have the cash.
There is no need to keep $21,650 in the bank when your annual expenses are less than $5,000. You almost have 5 years’ worth of expenditure saved up. Not to mention you make a profit, which makes such large cash reserves even less necessary. Invest some of this cash in a savings account and start earning some interest revenue, or spend the cash on expansion. You could also pay a dividend or pay yourself an owner’s salary.
Try again

Observation 5:
Do you see rent expense?Yes No

You aren’t paying rent. This means you’re working from home or on the move. You might find it beneficial to find a premises and start benefitting from foot traffic/walk in customers.
Try again

Observation 6:
What is the car worth after depreciation?

Are you Sure?Yes No

Your most expensive asset is your delivery car, worth $2,600. However, your sales are not high enough to warrant a delivery car yet. A vehicle is an expensive asset to have – you need to maintain it, repair it, insure it, put petrol in it, clean it and register it. You even need to find somewhere to park it each night! Consider using a shipping service to deliver your product at $10 a pop, and sell your car to put that $2,600 to better use
Hint (Depreciation amount is $400)
 

Now, some of these suggestions may be worthwhile and some of them may not, but that is beside the point. The lesson here is, from just looking at a profit and loss and a balance sheet - two reports which fit on one piece of paper, you can derive such a wealth of information about your business. Not only can you ascertain exactly where your money is coming from and going to, you also have enough information to make a decent list of ideas and suggestions about areas of concern and improvement. Now just imagine what an effective consultant could come up with for a large corporate like Toyota or McDonald's, armed with a few more pages of financial information.

The key to good decision making is good information – that’s what accounting is all about!

 

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