How to Read Financial Statements: A Practical Guide for Alberta Business Owners

Your financial statements can tell you whether the business is profitable, whether customers are paying on time, how much debt the company carries, whether expenses are increasing too quickly and whether the company has enough working capital to meet its obligations.

The problem is that many business owners receive financial statements from their accountant each year but do not know exactly what to look for.

Here is a practical guide to understanding the numbers.

Start With the Balance Sheet

The balance sheet shows the financial position of a company at a specific date.

It is built around a simple relationship:

Assets = Liabilities + Equity

Assets represent what the company owns or is entitled to receive.

Liabilities represent what the company owes.

Equity generally represents the owners’ interest in the company after liabilities are deducted from assets.

Unlike an income statement, which covers a period of time, the balance sheet is a snapshot at one particular date.

What Should You Look for in Your Assets?

Common assets may include:

Cash
Accounts receivable
Inventory
Prepaid expenses
Investments
Equipment
Vehicles
Buildings
Other capital assets

Do not focus only on the total.

The composition of the assets can tell you much more.

For example, a company may report $300,000 of current assets, which initially looks strong. But if most of that amount consists of old accounts receivable that may be difficult to collect, the company’s actual liquidity may be much weaker.

This is why the balance sheet should be considered together with supporting information such as an accounts receivable aging report.

Pay Attention to Accounts Receivable

Accounts receivable represents money customers owe the business.

A growing receivable balance can be positive if the business is growing, but it can also indicate collection problems.

Compare the balance to:

Prior years
Current sales
Customer payment terms
Your receivable aging report

If sales increased by 10% but accounts receivable increased by 50%, it may be worth asking why.

Are customers taking longer to pay?

Are invoices being disputed?

Are collection procedures being followed?

Are some balances no longer collectible?

Profit recorded on an income statement does not necessarily mean the related cash has been collected.

Understand Your Liabilities

Common liabilities include:

Accounts payable
Credit cards
GST payable
Payroll remittances
Corporate taxes payable
Lines of credit
Equipment loans
Vehicle financing
Mortgages
Other long-term debt

Increasing debt is not automatically a problem. Businesses often borrow to acquire equipment, expand operations or finance growth.

The important question is whether the business can comfortably service that debt from its operations.

A business owner should understand not only how much the company owes, but also when those amounts become payable.

Working Capital Matters

One useful measure of short-term financial health is working capital.

Working Capital = Current Assets − Current Liabilities

For example:

Current assets: $250,000
Current liabilities: $175,000

Working capital: $75,000

Positive working capital generally means current assets exceed current liabilities.

But again, quality matters.

A company with $100,000 of cash has a different liquidity position from a company with $100,000 of slow-moving inventory or overdue accounts receivable.

Financial ratios should therefore be interpreted in the context of the business rather than viewed in isolation.

Look Closely at Shareholder Accounts

For owner-managed corporations, another important balance sheet account is often the shareholder loan.

A shareholder loan can arise when an owner:

Puts personal money into the corporation
Pays corporate expenses personally
Withdraws money from the corporation
Has personal expenses paid by the company
Receives advances from the corporation

Owners should understand whether the corporation owes money to them or whether they owe money to the corporation.

There can be tax implications associated with shareholder transactions, so unexplained shareholder balances should be discussed with your accountant rather than allowed to accumulate year after year.

Next, Review the Income Statement

The income statement shows the company’s financial performance over a period, such as one month, one quarter or one year.

At a basic level, it reports:

Revenue − Expenses = Profit or Loss

But the bottom-line profit should not be the only number you review.

Understanding how the business earned that profit is much more useful.

Revenue: Look Beyond the Total

Start by comparing revenue to previous periods.

Ask:

Did revenue increase or decrease?

Was the change expected?

Did the business add new customers?

Were prices increased?

Did one large contract cause the increase?

Did the business lose an important customer?

Is the company becoming dependent on one source of revenue?

A 20% increase in sales may look excellent, but it needs context.

If costs increased by 35% at the same time, the additional sales may not have created additional profit.

Gross Profit Can Tell You More Than Revenue

For businesses that separately report cost of sales, gross profit is a useful measure.

For example:

Revenue: $1,000,000
Direct costs: $650,000
Gross profit: $350,000

Gross margin: 35%

Suppose the next year revenue increases to $1,200,000, but direct costs increase to $850,000.

Gross profit is now $350,000.

Despite generating an additional $200,000 of revenue, the company has not generated any additional gross profit.

That is something management should investigate.

Changes in gross margin may result from:

Pricing
Material costs
Labour costs
Supplier increases
Product mix
Project overruns
Discounts
Waste or inefficiency

Revenue growth without margin analysis can create a misleading picture of performance.

Review Expenses by Category

Do not simply look at whether total expenses increased.

Compare major expense categories individually.

For example:

Advertising
Insurance
Rent
Payroll
Professional fees
Repairs
Vehicle expenses
Interest
Software
Subcontractors
Office expenses

A large change is not necessarily an error.

It may have a perfectly reasonable explanation.

What matters is understanding why it changed.

If payroll increased 30% while revenue increased 5%, management may want to determine whether the additional staffing is generating the expected results.

If professional fees increased significantly, there may have been a one-time legal or consulting project.

Good financial analysis starts with asking questions about unusual movements.

Profit Is Not the Same as Cash

This is one of the most important accounting concepts for business owners.

A company can be profitable and still experience cash-flow problems.

For example, imagine that your company completes $200,000 of work in December and records the revenue.

The customers do not pay until February.

The December income statement may report a profit, but that does not mean the $200,000 is sitting in the company’s bank account.

At the same time, the business may have already paid:

Employees
Suppliers
Rent
Insurance
Loan payments
GST
Other operating expenses

The timing difference between earning revenue and collecting cash is one reason growing businesses sometimes experience significant cash-flow pressure.

Where a statement of cash flows is prepared, it helps explain how cash moved through operating, investing and financing activities during the period.

Compare More Than One Year

A single year’s financial statements provide useful information.

Several years provide a trend.

Consider comparing three to five years of information where available.

Look at:

Revenue
Gross margin
Payroll
Operating expenses
Net income
Cash
Receivables
Debt
Working capital

Trends often reveal information that is difficult to see from one year alone.

For example, a company may still be profitable, but its profit margin may have declined each year for four consecutive years.

That deserves attention before the business reaches the point of reporting a loss.

Compare Actual Results to Your Budget

Historical financial statements tell you what happened.

A budget tells you what you expected to happen.

Using both is much more powerful.

If annual revenue was budgeted at $1.5 million but actual revenue was $1.2 million, management should determine why.

If repair costs were budgeted at $25,000 but reached $60,000, the company may need to investigate aging equipment or revise future budgets.

Regular budget-to-actual analysis can help identify issues during the year rather than months after year-end.

Don’t Ignore the Notes

When a full set of financial statements includes notes, read them.

The notes may provide information about:

Accounting policies
Debt
Capital assets
Related-party transactions
Commitments
Contingencies
Significant estimates
Other important financial matters

The numbers on the face of the statements do not always provide the complete picture.

What Will Your Bank Look At?

Banks and lenders may analyze financial information differently depending on the financing arrangement, but they commonly pay attention to matters such as:

Profitability
Cash flow
Working capital
Debt
Debt-servicing capacity
Owner equity
Accounts receivable
Financial trends

Loan agreements may also include specific financial covenants.

Business owners with financing should understand these requirements and monitor them throughout the year rather than waiting until the financial statements are provided to the lender.

Use Financial Statements as a Management Tool

Financial statements should not be documents that you look at once during tax season and then put away.

They should help answer questions such as:

Is the business becoming more profitable?

Are customers taking longer to pay?

Are our margins improving or declining?

Can we afford additional debt?

Why did a particular expense increase?

Do we have enough working capital?

Which areas of the business require attention?

The better you understand your numbers, the more useful your accounting information becomes.

Financial Statement and Accounting Services in Edmonton

Seniuk & Marcato, Chartered Professional Accountants provides financial statement preparation, compilation, review, audit, bookkeeping and corporate accounting services to businesses in Edmonton and throughout Alberta. The firm works with organizations ranging from small owner-managed businesses to corporations, municipalities and not-for-profit organizations.

If you have questions about your company’s financial statements or want better financial information for decision-making, contact Seniuk & Marcato to discuss your accounting needs.

This article provides general information only and should not be considered accounting, tax, investment or financial advice for a specific situation.

Welcome to Seniuk and Marcato, Chartered Professional Accountants, where expert financial solutions and precision meet. Trust us to navigate your finances to your growth.