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Decoding Financial Statements: Our 5 Must-Know Tips

Financial statements are more than just sheets of paper filled with numbers—they are the narratives of a business's story. Understanding these documents is crucial for anyone looking to dive into SME lending or manage a business effectively.


Here are five essential tips to help you decode financial statements, making you a savvy interpreter of financial health.


1. Understand the Composition of Financial Statements


Every number in a financial statement stems from myriad factors: human actions, system outputs, business processes, or consumer behaviours. Recognising this helps you appreciate the complexity behind the figures.


When you know how financial statements are put together, you can better analyse the operational strengths and weaknesses of a business.


This insight is invaluable when assessing a company's viability and sets you apart as a true finance professional.


2. Conduct an Eye Check for Trends and Obvious Questions


Leave the calculator in the pocket and start with an eye check of the financial statements.


Look for trends in revenue growth, gross profit key expenses and net profit over multiple periods. Are there significant fluctuations or a steady trend?


Each line item tells part of the story—be ready to ask why certain numbers may have changed or explain line items you don’t understand like large miscellaneous or sundry expenses.


This initial scan sets the stage for a deeper analysis and can highlight potential areas of concern or interest. Asking more questions at this stage can help you save a lot of time down the line


3. Grasp EBITDA and Its Application


EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortisation) is a widely used metric to assess a company's operational efficiency and profitability.


However, it's important to apply it judiciously. Know which elements to adjust for a fair picture and which might paint too rosy a scenario for a particular business.


Understanding the nuances of EBITDA can help you quickly get a picture on the true trading performance and being conservative in your approach can prevent overstating a business’s operational performance.


4. Don’t Overlook the Balance Sheet – The Engine Room of the Business


While profit and loss statements capture attention of business owners and finance professionals like, the balance sheet is where the enduring value of a business lies. Think of the balance sheet as the engine room of the business—where the true power of the business lies.


It shows the assets, liabilities, and equity, and is essential for understanding the company's structure and the potential for long-term stability.


 It can also expose all matter for future opportunities for you to work with a business client on, from asset finance to property purchases through to working capital support.


5. Cash is King: Master These Three Ratios


If the balance sheet is the engine room, Cash is this engines fuel and having a solid grasp of how a business’s cash is generated and spent can turn you into an essential partner for your SME clients.


Cash flow is the lifeblood of any and you can quickly enhance your financial literacy by focusing on just three critical ratios: stock days, payable days, and receivable days.  These ratios help you understand how efficiently a business is managing its inventory, paying suppliers, and collecting from customers.


Mastering these can give you a significant edge in predicting financial pressures and opportunities in cash flow.


Becoming proficient in reading and interpreting financial statements is an invaluable skill that can set you apart in the financial world.


Whether you’re a budding entrepreneur, a finance professional, or an SME broker, understanding the intricacies of financial documents is crucial.


For those looking to deepen their knowledge, consider our SME Broker advantage program or short courses.  They are designed to fill any gaps in your understanding and empower you with the expertise to make well-informed decisions.


Dive into our resources today and turn financial confusion into clarity today.

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