What Do the Financials Actually Tell Me?

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Have you ever heard a conversation being conducted in a language you did not understand?  Or even more distressing, have you ever tried to obtain some very important information, but you did not speak or even read the language that information was provided in? 

In the world of business valuation, one of the most important pieces of information we use are the Company’s financial statements.  Most people who work with privately held businesses as counselors, consultants, advisors, or any other type of expert are familiar with an income statement, also known as a profit and/or loss statement depending on one’s preference.  This is the record of the revenues earned by a Company and a listing of all the expenses that were recorded against it with a bottom-line number explaining what the Business’ profit was for the time period.

However, there are many of these same counselors, consultants, advisors, or experts who are less familiar with some of the other financial statements provided by a qualified accountant.  Balance sheets provide a listing of the assets and liabilities owned by the Company (at a specific point in time), but the variety of interesting ways the equity section gets broken up into, tends to confuse a few people.  I know several business brokers for example, who are very successful in their chosen field, but who also freely admit that they do not understand how a balance sheet inter-relates with the associated income statement.

Then there is the Statement of Cash Flows.  This statement is a bridge between the balance sheet and the income statement and provides some very useful information, but is also the statement that most often gets omitted from the collection of statements an accountant can provide.  As a business appraiser, I really love this financial statement and the data it provides, but even fewer counselors, consultants, advisors, or experts are as familiar with it as they want to be. 

A Company’s financial statements are the record of historical results, the roadmap as it were, of how the business has performed historically.  As useful and important as they are to a business appraiser, they are only half of the picture. 

It is a wonderful thing to be able to compare the business to itself over time, to see the business improve or decline and identify the reasons for those changes, but unless we also compare the Company’s results to its industry averages, we are missing out on the most important pieces of the puzzle! 

I read a very well written business appraisal report, where the conclusion was, because the business had been improving its profitability by several percent every year over the historical period analyzed, that the risk of operations must be much less, and so the appraiser selected a lower specific company risk premium in his valuation.  However, when I compared the Subject’s profitability to its industry and saw that the Company’s profit margins were still well under the industry averages’, I suggested to the appraiser that he had over-valued the Business as its most profitable year was still less profitable than the industry average.

We use financial ratio analysis to compare a Business to its industry averages.  There are several databases available that provide industry benchmarking data for this use.  However, if we are unfamiliar with the language used to describe all of the Company’s financial statement data, it becomes even harder to successfully analyze the Subject alongside its industry.

The ISBA has scheduled a live, extended webinar where our instructor will describe how to read financial statements, explain the differences in analyzing financial statements for large and small businesses, and also provide a case study where he will walk attendees through a financial ratio analysis comparing the Subject to its industry average, explaining what each ratio actually means and how each one will affect the final value conclusion.  This course will be offered on August 13th, 2019 and will be held in two parts with a break for lunch in the middle. 

If you have any questions, please contact me.  I can be reached at 469-412-9935 or at shyde@intlBCA.com.

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