Analysing the health of your business

As a business leader or an investor, knowledge of how to interpret financial statements is very important. You don’t necessarily need to have done a degree in accounting. You just need to have an appreciation of the main statements that comprise the financial statements of an organisation and then be able to interpret the changes in the figures from month to month or from one year to the other.

The first of these statements is the income statement sometimes referred to as the profit and loss statement. An income statement measures the financial performance of an organisation over a specific period; monthly, quarterly or annually.
The statement summarises the performance of the organisation by showing the income earned and expenses incurred by both operating and non-operating activities. The net of the income and expenses is either a profit or loss. The performance of the entity will then be judged on whether it’s making a profit or not.
The section of the income statement that is of interest when assessing the performance of an organisation is that showing operating activities because this shows activities directly related to the core activities of the business. If the entity is dealing with selling clothing, the operating activities will show the income from sales of clothes, the cost of those clothes and the expenses directly resulting from doing this business.

Analysis of these activities will show if a business is doing well. However, non-operating activities for the clothing business would be things like sales of shop fittings. Such sales are not part of the normal clothing business but might have resulted from old or excess shop fittings that need to be disposed of.
The second of these statements is the balance sheet. The balance sheet summarises an organisation’s assets, liabilities and shareholders’ equity at a specific point in time like at the end of the month, quarter or at the end of the year. This statement is referred to as a balance sheet because it has to balance.

Total assets should equal the total of liabilities and money invested by shareholders (shareholders equity). You can look at it this way; an organisation buys assets by using money either obtained through loans/borrowing or from cash injected into the business by shareholders or investors.
The balance sheet therefore has these three segments: assets, liabilities and shareholders’ equity and can be expressed as an equation: assets =liabilities + shareholders’ equity. Each of these balance sheet segments will have a number of accounts. For instance assets would be made up of cash, debtors, stocks and fixed assets (e.g. vehicles, equipment), liabilities will be made up of loans, creditors, bank overdraft and taxes owed and shareholders’ equity will show the amount invested by investors or owners of the business and any profit not paid out as dividends.
The list of accounts indicated above is however not exhaustive. It’s all dependent on the type of organisation.

The last of these statements is the cash flow statement which basically shows the amount of cash and cash equivalents entering and leaving the company. The statement complements the income statement and the balance sheet in that it links the activities of these statements. The cash flow statement allows those analysing the organisation to see how the entity is being run, where is the cash coming from and how is it being used. The cash flow statement records only cash related movements. Anything bought or sold on credit will not be considered; only cash movements will be recorded. The cash flow statement has three segments to it, namely, cash movements related to operating activities, the cash movement relating to investing activities and cash movements in financing activities.

Cash movements from operating activities are those arising from the core activities of the organisation and would usually be cash sales, trade debtors and trade creditors. This will show the cash generated by the organisation’s products and services.

Investing activities relate to all cash movements in equipment, other assets or investments. The movements in cash under this section would mostly refer to purchases or disposals of assets.
The last of the cash flow statement segments is the financing activities. This section records the movements in loans, debt, capital injection and dividends. If an organisation receives funds from shareholders or from loan providers, this will be recorded as cash in and payment of dividends is cash out.

The net of these cash flow statement segments will give us the cash position of the organisation; how much cash does the organisation has.
Analysis of the three statements, namely, the income statement, balance sheet and cash flow statement will indicate the financial health of the organisation from one year to the other and also among its peers in the industry sector it’s operating in. As an investor, employee or creditor, you will be able to tell whether a business is in trouble or worth investing in by analysing changes in these three statements.

l Stewart Jakarasi is a business and financial strategist and a lecturer in business strategy (ACCA P3), advanced performance management (P5) and entrepreneurship.
He is the Managing Consultant of Shekina Consulting (Pty) Ltd and provides advisory and guidance on leadership, strategy and execution, corporate governance, preparation of business plans, tender documents and on how to build and sustain high-performing organisations.
For assistance in implementing some of the concepts discussed in these articles please contact him on the following contacts: sjakarasi@gmail.com, call on +266 58881062 or WhatsApp +266 62110062.