Financial Clarity
Financial Clarity is about understanding the financial position and performance of your company, the financial resources available to take advantage of opportunities, and the risks associated with company performance and survival. Tracking financial metrics has no other purpose than to inform the reader of these positions, opportunities, and risks. However, just knowing the numbers doesn’t provide that level of insight. Clarity comes from understanding what the financial numbers mean and how they are positioned in relation to company goals, industry performance or other expectations.
Technically, there are 4 core financial statements that should be used by businesses. They include the Balance Sheet (BS), the Income Statement (IS), the Statement of Cash Flows, and the Statement of Changes in Equity. The most common and the ones we’ll briefly discuss here are the Balance Sheet and the Income Statement. While the other 2 provide valuable information and acknowledging the fact that there are numerous other supporting financial reports that can be utilized, the BS and IS are the most frequently relied upon by business leaders, lenders, and investors.
The BS describes the financial position of your company at a particular point in time. It includes all your assets, liabilities, and equity. There are a number of components in each of these categories that provide valuable information to the business, but 3 of the most commonly reviewed metrics include Liquidity which shows how much cash, or near cash assets, you have to run the company (the higher the better), Leverage is the relationship between how much you owe others as compared to your total assets or equity (the lower the better), and Equity defines how much of the company you would own after satisfying all your creditors (obviously the higher the better).
The IS represents the financial performance of the company over a period of time. In general, it will include the Revenue generated (the higher the better), the Expense incurred (the lower the better), and the resulting Net Income (Revenue less Expenses – the higher the better) over that period of time. From this information Profit Margins are calculated. The Gross Profit Margin (net revenue less cost of goods sold/net revenue) is displayed as a percent of net revenue indicates the profit made before operating expenses. The Net Profit Margin represents the percent of Net Revenue remaining after all expenses. In both instances the higher the margins the better for the company.
Whatever financial metrics you choose to track for your company they must be meaningful. In other words, you must understand them at a level that allows you to alter them through strategic initiatives and management actions. If you don’t understand how to impact any given metric it won’t do you much good knowing what it is.
The frequency of financial reporting varies between companies and should be determined by the speed of which the company would prefer to respond to unfavorable circumstances or to take advantage of situational opportunities. The more frequent financial position and performance are reviewed the more agile, or flexible the company will be. Typically, the more frequent the better.
Think about it this way, Let’s assume you’re a pilot flying a plane from the east coast to the west coast. You get plane and flight information, including a flight plan to reach your intended destination. After takeoff you do not receive updated information until halfway through the trip. Your instruments and communication don’t work and you’re just flying in the general direction based on instinct. What do you think the chances are that your flight will not encounter any issues along the way and that you will arrive at your intended destination? Probably not. Regular information on position and progress is critical for your business to achieve your intended destination and goals.
Reading your financial statements on a frequent basis can become burdensome and it’s easy to get lost in the numbers. This is where Dashboards come in. Dashboards can be easily produced and provide focus on specific financial metrics. You should identify the top 5 to 10 key financial metrics for your company. Different industries will have different metrics and different reporting cycles. When I was a bank president there were certain metrics that I looked at on a daily basis. The dashboard was generated at the end of each day and available for my review first thing the next morning. Other dashboards provided information on a weekly, monthly, quarterly, and/or annual basis.
These dashboards were designed to provide an understanding of 6 different perspectives. For each metric charts and graphs were presented with the Status, Position, and Trend (SPT) of the metric as well as our Target, Tolerance, and Threshold (T3) level. With this approach I could determine the need for more information or the need to implement actions that would redirect our effort and keep us on course.
Follow these 5 steps to obtain financial clarity for your business:
1. Learn your financial statements in detail and understand what they’re telling you.
2. Identify your top 5 – 10 key financial metrics that, if materially changed, could significantly alter the course of your business.
3. Determine the appropriate frequency for the review of these financial metrics.
4. Establish Dashboards that report the SPT and T3 for each financial metric.
5. Monitor and Course Correct appropriately.
Gaining financial clarity and establishing an effective monitoring program is easier said than done. Work with a trusted advisors to help get you started. For an initial assessment of your current financial clarity and guidance on establishing an effective financial clarity program reach out to me at Richard@StrategicOrientation.com.
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Have a great day!
Richard