If you are like many entrepreneurs, you started your business based on a passion. Maybe your passion is technology or sustainability or customer service … or financial statement analysis. Financial statement analysis?! Not likely! 

Naturally, you have a gut instinct or feel for the business, your sales, what’s working and what isn’t. However, at least once a year, every small business owner should take time to carefully review the financials to back up his or her instincts with real numbers. Here are some things to look for.

Making Comparisons

Compare the annual and quarterly numbers to the previous period. At least annually, it is critical to conduct a line-by-line review of your financial statements to look for variances compared with the prior period.

For example, were your revenues up or down last year? Can you explain why? Were there other anomalies—either positive or negative? Maybe the change is due to some outlying large orders that may not repeat again in the future, or maybe the price increases you implemented six months ago have led to a steeper-than-expected drop in volume.

Now, ask yourself the same type of questions about expenses. Is your productivity dropping because wage expenses are rising faster than revenues? Maybe you’re paying more overtime than you expected, or maybe you’ve had staff turnover and your new employees are still ramping up their productivity.

It is also important to evaluate your working capital situation. For example, are orders translating to actual sales? Have accounts receivable and inventory been building or shrinking? Do you have sufficient liquidity to deal with a spike in orders? By knowing your numbers inside and out and by maintaining a disciplined approach, you will set up yourself—and your business—to address pitfalls and seize opportunities.

Create an Annual Budget

The only certainty about an annual budget is that, most of the time, you will either over- or underperform. Nevertheless, creating an annual budget is an important discipline to establish guideposts for your business.

As you prepare next year’s budget, it’s not wise to randomly decide that top-line revenues will grow by a certain percentage. The keys are why and how revenues will grow. For example, are you expanding into a new territory or a new product area? Are you implementing
a price increase? Do you plan to increase
compensation among team members? Have you factored the increasing costs of raw materials into your analysis?

Be sure to incorporate the insights you gained from your review of the prior period’s financial statements. Again, go line by line, account by account. In addition to this bottom-up approach, you should incorporate top-down thinking, such as industry trends and moves being made by competitors. Be very clear in your analysis to better anticipate the needs of your customers and the results of your business. Finally, when conducting your annual review of the financials, be sure to evaluate how your company performed versus budget.

Review Your SKUs

Think about the product mix you offer in the marketplace and how it impacts your bottom line—and every line in between. What are your top 10 sellers? What are your 10 bottom dwellers? Is it time to eliminate the underperforming products to make room for those that are actually in demand? What impact might such a move have on your established customers? With what could you replace your bottom sellers to bolster overall sales? Any chance of beefing up sales of your best sellers?

Clearly, the numbers are critical to the survival of any business. Again, we’re not taking profit and loss statements at face value—instead, an entrepreneur must be keenly aware of the messages the operational figures are sending. Recognize that the messages may serve as warnings of potential points of failure for your organization. And, on the brighter side, they may also hint at opportunities just waiting to be seized.