Basics of Financial Analysis

BookKeeping Express | Basics of Financial Analysis Basics of Financial Analysis Part I: Terminology, Tools, and Ratios – March 13 Part II: Where do you start? – March 20 Part III: Income Statement – March 27

BookKeeping Express | Basics of Financial Analysis The purpose of these three sessions is not to make you a financial analyst, or even a CFO. Our goal is to give you a working knowledge of what you should be looking for when working with clients, to help you better understand their business, and to allow you to give them input on how to be better businesspeople. In three sessions, we will cover terminology, tools, ratios, where to start, and how to read an income statement. We will conduct a review at the end of the three sessions to determine additional learning needs.

BookKeeping Express | Basics of Financial Analysis Part I Terminology Tools Ratios

BookKeeping Express | Basics of Financial Analysis Part I Terminology

By definition, Cash Accounting creates the transaction when a payment is made or received. Conversely, Accrual Accounting creates the transaction when the event occurs, regardless of when payment is made or received. If transactions are only being entered from bank and credit card statements, you are doing Cash Accounting regardless of what the reports you print show. BookKeeping Express | Basics of Financial Analysis Cash Accounting vs. Accrual Accounting

Terminology Financial Accounting tells the history, while Managerial Accounting projects the future based on the past. Giving the client only the Financial Accounting, which is what they are familiar with, is bookkeeping. The secret to being the trusted partner and providing added value is talking to them about the Managerial Accounting, and convincing them you are not doing it by looking at a crystal ball. The rest of these sessions will be talking about Managerial Accounting. BookKeeping Express | Basics of Financial Analysis Financial Accounting vs. Managerial Accounting

Terminology This is just as the name implies: certain costs, such as rent, are Fixed Costs because they are the same every month. Others may still be considered Fixed Costs, even though they are not exactly the same, like you phone bill or copier expense. A Variable Cost is one that is directly related to the sale of or the purchasing of product for inventory. BookKeeping Express | Basics of Financial Analysis Fixed Costs vs. Variable Costs

BookKeeping Express | Basics of Financial Analysis Part I Tools

This is the listing of all Current and Long Term Assets and Liabilities for the company. The difference in the two, whether positive or negative, is the equity of the firm. Because it is for single points in time, whether that is end of month, end of quarter or end of year, by itself it won’t give you much information. You will need to do a comparison. BookKeeping Express | Basics of Financial Analysis Balance Sheet

Tools Also known as Profit and Loss Statement, which to me is a misnomer. It could be a Profit or Loss Statement, but can’t be a Profit and Loss Statement. If a business owner has any financial information other than their check book, they will refer to this as their “go to” piece rather than the Balance Sheet. The Income Statement is a rolling document showing how the company is doing from the first day of a fiscal period to the date set. This can be a useful tool if the Chart of Accounts is set up to tell you what you need to know. BookKeeping Express | Basics of Financial Analysis Income Statement

Tools These are ancillary reports that you will need to do the Managerial Accounting, but are only available if the client is doing Accrual Accounting. If input is only received from the bank and credit card statements there will be no Accounts Payable or Accounts Receivable and therefore there can be no Cash Flow Report. BookKeeping Express | Basics of Financial Analysis Cash Flow, Accounts Payable, and Accounts Receivable Reports

Tools Industry Standards Reports like Profit and Sense are interesting and certainly have a place, but to help a specific client you will need to rely on their numbers and compare their numbers. Use Industry Standards in the beginning to show the client what a “goal” could be, but use it sparingly. BookKeeping Express | Basics of Financial Analysis Industry Standards Reporting vs. Client Specific Reporting

BookKeeping Express | Basics of Financial Analysis Part I Ratios While there are probably as many financial ratios as there are lines on a balance sheet, I think there are four important ones that you should be able to roughly calculate in your head and discuss with the client during your first meeting. Again, this will get you out of the mindset of being a bookkeeper and instead being their CFO or analyst partner.

Ratios This is the Current Assets compared to the Current Liabilities. Since Current Assets and Liabilities are considered cash or near cash, this will help you see the liquidity of the firm. Could they pay off what they owe and continue in business? The goal is to have 2 to 1 assets to liabilities. Again, you should be able to get a pretty good number just by looking and doing some rounded math in your head. BookKeeping Express | Basics of Financial Analysis Current Ratio

Ratios This is the same as current ratio but eliminates inventory if they have any. If there is no inventory than Quick and Current are the same thing. BookKeeping Express | Basics of Financial Analysis Quick Ratio

Ratios Sales divided by Accounts Payable. This will show you how quickly they are paying vendors without looking at the AP Aging report. BookKeeping Express | Basics of Financial Analysis Accounts Payable Ratio

Ratios Credit Sales divided by average Accounts Receivable. If you don’t have an average AR because you don’t have two period to compare you can do this off the AR on the Balance Sheet you have. This will show you how long it takes to collect the money without an AR ageing report BookKeeping Express | Basics of Financial Analysis Accounts Receivable Ratio

Ratios Now compare AP ratio to AR ratio and determine if they are collecting the AR to pay vendors, or are they using their own assets. As I get to work with a client I also show them the value of getting a discount if they can pay vendors quickly. For example if they can get 2/10 net 30 and can pay in the 10 days they get the equivalent of 37.24% interest on their money for the reduced payment. (Discount %) divided by (1-Discount %) X (365 divided by number of days of early pay).02/(1-.02) X (365/20) = (.02/.98) X = 37.24% BookKeeping Express | Basics of Financial Analysis Tip: Compare AP Ratio to AR Ratio

BookKeeping Express | Basics of Financial Analysis Questions?

BookKeeping Express | Basics of Financial Analysis Basics of Financial Analysis Part I: Terminology, Tools, and Ratios – March 13 Part II: Where do you start? – March 20 Part III: Income Statement – March 27

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