Spring is the time of year that calendar-year-end businesses receive financial statements that conform to U.S. Generally Accepted Accounting Principles (GAAP). This year, take your financial statements beyond compliance and use it to develop a comprehensive business plan. Also, assess how your business measures up over time and against the competition. Here’s how financial statements can be used to be proactive, not reactive, to changes in the manufacturing industry.
Forecasting the future
Historical financial statements are often the starting point for planning for the future. Comprehensive business plans include forecasted balance sheets, income statements and statements of cash flows.
Many items in your forecasts will be derived from revenue. For example, variable expenses and working capital accounts are often assumed to grow in tandem with revenue. Other items, such as rent and management salaries, are fixed over the short run.
These items may need to increase in steps over the long run. For example, a company may eventually need to expand its factory or purchase equipment to grow if it is currently at full capacity.
By tracking sources and uses of cash on the forecasted statement of cash flows, management is able to identify when cash shortfalls may happen and plan how to make up the difference. For example, the company might need to draw on its line of credit, request additional capital contributions, lay off workers, reduce inventory levels or improve its collections. In turn, these changes will flow through to the company’s forecasted balance sheet.
Historical financial statements can also be used to evaluate the company’s current performance versus past performance or industry norms. A comprehensive benchmarking study includes the following six elements:
This is usually in terms of annual revenue, total assets or market share.
This shows how much the company’s size has changed from previous periods.
Working capital ratios help assess how easily assets can be converted into cash and whether current assets are sufficient to cover current liabilities.
This section evaluates whether the business is making money from operations, before considering changes in working capital accounts, investments in capital expenditures and financing activities.
Such ratios as total asset turnover (revenue divided by total assets) or inventory turnover (cost of sales divided by inventory) show how well the company manages its assets.
Identify how the company finances its operations — through debt or equity. There are pros and cons of both.
How does your company measure up against other manufacturers? Contact your CPA for help benchmarking performance or creating forecasts from your GAAP financials.